Is a Student Loan Settlement Possible for You?

You may be able to settle federal or private student loans for less than you owe if they’re in default and you can’t repay them.

Ryan LaneJuly 24, 2020
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Student loan settlement is possible, but you’re at the mercy of your lender to accept less than you owe. Don’t expect to negotiate a settlement unless:

  • Your loans are in or near default.

  • Your loan holder would make more money by settling than by pursuing the debt.

  • You have or can save enough cash to pay the settlement amount in full or over a few installments.

Don’t miss student loan payments to try and force a debt settlement. You’ll severely damage your credit, collection costs can be added to the amount you owe, the savings may be less than you hope and there’s no guarantee your lender will negotiate with you.

» MORE: Debt settlement: how it works and risks you face

When you can settle student loans

Federal and private student lenders will require your loans to be in or near default to start settlement negotiations. Federal student loans enter default after 270 days of past-due payments. Timelines vary for private student loans, but default often occurs after 120 days of missed payments, according to the Consumer Financial Protection Bureau.

Federal and private student loans are rarely discharged via bankruptcy. Federal student loans have other options that could eliminate your debt. Defaulted federal student loans can be discharged in instances such as school fraud and total and permanent disability, but they aren’t eligible for loan forgiveness. If you’d otherwise qualify for forgiveness, return your loans to good standing instead of settling them; you’ll likely save more money.

Reasons for federal student loan settlement

Federal student loan settlements are not common because the Department of Education and other federal student loan holders have ways to get money from defaulted loans, such as wage and tax refund garnishment. They may make an exception in the following situations:

There is no set hardship standard for debt settlements. You’ll likely have to provide copies of your tax returns, pay stubs or other documentation to make your case.

One sign your payments are too large is if you qualify for Pay As You Earn or Income-Based Repayment. Those repayment plans require that you have a partial financial hardship, according to the Department of Education's calculations.

Rehabilitation is the best option for recovering from default because it removes the default from your credit history; debt settlement will not. But you can rehabilitate defaulted loans only once. If you’ve re-defaulted on the same loan, your loan holder may be more willing to work with you due to your limited options.

Your loan holder may accept a debt settlement because it can’t get the money from you any other way. For example, you moved out of the country and can no longer have your tax refunds seized or wages garnished.

» MORE: How to get student loans out of default

Reasons for private student loan settlement

Settlements for defaulted private student loans are more common because these lenders don’t have the collection leverage of their federal counterparts. A private loan holder may accept a settlement in the following instances:

Your loan holder will likely make its decision based on its perception of your ability to repay. You’ll need to show why it won’t be able to get much money from you in the future, such as you’re suffering from a long-term financial hardship.

Private loan holders can force repayment by suing you. In certain states, if your loan holder wins a court judgment, it could gain the ability to garnish your wages or take money directly from your bank account.

But if you can prove in court that the statute of limitations on your student loans has expired or the debt is unenforceable for another reason, you could prompt a settlement — or dismissal of the debt.

How much student loan settlement could save you

Private student loan debt settlement amounts vary greatly. Experts say some lenders may not accept less than 80% of the total owed, whereas other lenders will take less than 50%.

Savings aren’t nearly as big for federal student loans. The Department of Education provides its loan holders with specific guidelines for how much of the debt is OK to waive. You may receive one of the following:

  • 100% of collection costs waived.

  • 50% of interest owed waived.

  • 10% of principal and interest waived.

If you have older loans originated under the Federal Family Education Loan Program, your guarantor — the organization that takes ownership of these loans in default — has an additional option: waiving 30% of your principal and interest.

Federal student loan holders can accept settlement offers for less than these amounts, but it’s rare. Alternate settlement offers require additional approval, either from within the organization or the Department of Education itself, as they further affect the loan’s profitability.

Whether you settle federal or private student loans, you may owe income taxes on the amount you don’t pay. Contact a tax professional to find out the implications for your situation.

How to get a student loan settlement

You can attempt to settle student loans on your own or with the help of a more experienced negotiator.

  • Make contact yourself. Reach out to the company that’s been in contact about your defaulted loan. For defaulted student loans, this will likely be a collection agency. Contact them and ask to discuss settlement options.

  • Hire an attorney. Choose someone who specializes in student loans or debt settlements. You will likely have to pay legal fees, and lawyers cannot guarantee better savings than you can get on your own. Attorneys can negotiate federal student loan settlements but may prove most helpful if your private student loan holder has sued you.

  • Work with a debt settlement company. If you’re still making payments, debt settlement companies will have you stop and fund an account with them instead. Once you’ve put enough money aside, the company will try to negotiate a settlement. Using a debt settlement company is risky, especially if your loans aren’t already in default. Only some of these companies help settle student loans, and some lenders won’t negotiate with debt settlement companies. Check that your lender will before selecting this option.

If you and your loan holder agree to a settlement, get the offer in writing. Once you’ve paid the amount as required, make sure you receive a paid-in-full receipt. You’ll want to hang on to that in case questions about your debt arise in the future.

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