Is a student loan settlement right for you? Pros, Cons, & Negotiation

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Stanley tate

Student Loan Lawyer

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Student loan settlement may be the saving grace for you to get out from under a mountain of student loan debt.

In a student loan settlement, you (the borrower) and your student loan lender agree that you can satisfy a student loan for less than you owe. This requires you to pay a lump sum of a large percentage of the principal balance and accrued interest.

You can only settle federal student loans and private student loans if the loans are already in default (or very close to defaulting). If your loans are in good standing, you won’t be eligible for a settlement.

Not everyone will be eligible to settle their student loans — ultimately, it’s up to the lender whether or not to settle with you. It’s also not the best option for all borrowers.

Whatever you do, don’t purposefully miss your student loan payments just to compel a settlement agreement. If you default on your federal student loans, the federal government can garnish your wages, garnish your tax return, or pursue other means to collect on your debt.

To determine if settling is the best fit for your situation, let’s discuss how settlement works and who is eligible.

When is federal student loan settlement an option?

You can enter negotiations to settle federal student loans after the loan is in default (270 days past due) and placed with a collection agency.

Federal student loans aren’t settled often because the Department of Education typically uses other means to obtain the money you owe.

However, the federal government may agree to settle your student loans when:

  • You can prove you can’t afford to repay the loan in full
  • The loan holder isn’t able to collect on your loan (for instance, if you’ve moved out of the country or hold no gainful employment)

For federal loans, you’ll need to wait until the loan has been transferred from the loan servicer to the Department of Education, then to a collection agency, before negotiating a settlement.

When is private student loan settlement an option?

You can enter negotiations to settle private student loans after the loan is in default (according to the terms of the promissory note) and when the private lender is willing to listen to settlement offers.

A private lender may be more inclined to settle a debt if:

  • You can prove that you have few-to-no assets and very little income, or
  • You are represented by an expert, like a student loan attorney

Many private loans default after 120 days (4 months) of non-payment, but this varies by lender. Typically, a private lender will begin listening to settlement offers 6 months after the last on-time monthly payment.

A student loan settlement is a good option if you can afford a lump sum to offer the lender, or if a lump sum plus monthly payments.

Monthly payments by themselves usually don't lead to great settlement offer.

What happens if I can’t pay my student loans?

If you can’t repay your student loans and fall behind on payments, they will first become delinquent and then default.

At this point, your choices for resolving your loans may include forbearance, deferment, settlement, or bankruptcy (in some cases).

Once in default, your loan is sent to a debt collector, where it will accrue collection charges that can cost up to 25% of the loan balance. You may also face other consequences, like:

  • Lawsuits and court orders
  • Increasing damage to your credit score
  • Wage garnishment
  • Tax refund garnishment
  • Garnishment of your Social Security benefits
  • Educational delays
  • Difficulties borrowing money for other circumstances, like a mortgage or an auto loan

It is often possible to make a settlement on student loans that are in default. Both federal student loans and private student loans may be resolved with a settlement plan, although it’s not guaranteed. The final answer is up to your lender.

How much money will I save by settling my student loan?

Typically, you should expect to settle a federal student loan for between 85-90% of the outstanding balance. This amount includes outstanding principal and interest.

When settling student loans, there are differences between federal student loans and private student loans.

Federal student loans almost never accept settlements for less than 85% of the outstanding principal and interest balance.

Private student loan settlements vary greatly depending on the lender. Usually, you can get a better deal than with federal student loan settlements.

Private student loans can often settle for between 40-70% of the current loan balance.

Can you settle student loans in good standing?​​​​

You cannot settle federal student loans or private student loans that are in good standing. With both federal and private loans, a student loan settlement doesn't become an option until you enter loan default — and that can take up to 270 days.

Of course, if you have good credit, the last thing you want is to have late payments reported to the credit bureaus — especially if you have a cosigner. But unfortunately, lenders aren't willing to get rid of the accrued interest or collection fees if your loan is in good standing. From their perspective, it doesn't make business sense to offer a discount for you to pay your loans early. The lender makes its money by collecting on the interest you pay each month. The longer you take to repay, the more money your lender makes.

The inability to get a settlement while you're loans are in good standing is one reason why borrowers consider a strategic default.

Pros of student loan settlement

Student loan debt settlement can be an excellent option for student loan borrowers who are in default. Even borrowers who are in delinquency should think about settlement. This may give them time to save a lump sum payment after defaulting.

The pros of settling student loans include:

  • Financial relief from loans you cannot repay
  • Preventing ongoing damage to credit (though the settlement goes on your credit report)
  • Removing the default status from your credit report
  • Improved debt-to-income ratio for future borrowing
  • Safety from more invasive collection measures
  • No further accrued interest or late payment fees

Each person is different, and each student loan scenario is different. That being said, what may be beneficial for some, may not be so for others.

Settlement can also bring significant mental relief. Once you’ve settled your student loan debt, the collection efforts like wage garnishment and forfeited tax returns stop. You’ll be able to begin repairing your credit.

Cons of student loan settlement

The cons of settling student loans include:

  • You will usually need a lump sum of money to offer the lender for a settlement
  • To settle, you’ll need to be in default, which will negatively impact your credit
  • The portion of the student loan waived in the settlement will be subject to income tax
  • It will show on your credit report that you did not pay the debt in full
  • In many cases, you may have to prove significant financial hardship — a standard determined by your lender, not by you

The obvious negative to student loan settlements is that you must have defaulted loans. As a result, you’ll already have much lower credit scores than the average person.

It’s impossible to predict precisely how defaulting or settling your student loan will impact your credit. However, payment history accounts for 35% of your FICO® Score — many months of missed payments will cause a significant drop. Plus, the missed payments stay on your credit for 7 years.

This credit impact can lead to difficulty obtaining a credit card, loans for cars or mortgages, and even complications with your job.

However, if you are currently in default, settlement may offer an opportunity to begin rebuilding your credit.

How to negotiate a federal student loan settlement

Once you default on your federal student loans, the U.S. Department of Education is often willing to settle your FFEL, Direct Loans, and Perkins loans.

To negotiate a federal student loan settlement:

  1. Check studentaid.gov to check your federal student loan repayment status and who the loan servicer is. The database will also list the debt collection agency.
  2. Call the collection agency and let them know you would like to settle your student loan.
  3. Use a polite tone to start the conversation off on a positive note.
  4. Negotiate the student debt settlement amount based on the lump sum you can afford to pay.
  5. Get the agreement in writing.
  6. Pay the settlement amount you agreed on with the lender within the specified timeframe.
  7. Make sure you receive written confirmation that the student loan has been satisfied.

Know your options ahead of time to negotiate effectively. Federal student loan settlements typically fit into one of these 3 options:

  • You pay the remaining principal and interest, plus any collection costs are waived.
  • You pay the principal and half of the unpaid interest accrued since the loan went into default.
  • You pay 90% of the current principal and interest balance.

Start by offering the minimum you think you can settle for. This leaves room for a counteroffer that may still be in your favor.

Keep in mind: Lenders are likely to sweeten the deal if they know you’re able to settle quickly with cash on hand.

How to negotiate a private student loan settlement

To settle a private student loan:

  1. For private student loans, there is no database to see all of your outstanding loans. If you aren’t sure of your private student loan servicer, you’ll need to get a copy of your credit report and compare it to the National Student Loan Data System (NSLDS). Any student loans on your credit report and not in the system are private loans.
  2. Contact your lender to let them know you would like to settle your student loan.
  3. Use a polite tone to start the conversation off on a positive note.
  4. Let your private student loan lender make the initial offer. This will give you a starting point as to what the lender is likely to accept.
  5. Negotiate the student debt settlement amount based on the lump sum you can afford to pay.
  6. Get the agreement in writing.
  7. Pay the settlement amount you agreed on with the lender within the specified timeframe.
  8. Make sure you receive written confirmation that the student loan has been satisfied.

Pro tip: Private student loans have a statute of limitations that vary from state to state. As more time passes, the lender is likely to accept better settlement options.

A lender is likely more willing to accept less if they know they can receive payment quickly. For smaller amounts, emphasize that the administration costs and legal fees will probably cost more than the amount owed.

What’s the best way to settle?

Negotiating a student loan settlement can be tricky. There is a lot to consider, and you’re working with companies trying to get the most money out of you.

You have 2 options when considering settling your student loans:

  • Do it yourself. You may try settling the debt yourself. While this may save you money in advisory fees, you take the risk of paying more than you need to without the knowledge of a professional. Settling can take time, back-and-forth, and tough talk. Negotiating for yourself is not everyone.
  • Get a lawyer. Hiring a lawyer specializing in the complex laws surrounding student loans can be a huge help and increases your odds of a favorable settlement. A lawyer can give you individualized advice and keep a barrier between you and a lender, avoiding oversharing personal details that could drive up the negotiation.

What to expect after settling

After you make your payment and fulfill the terms of the settlement, you will receive a debt clearance letter. This letter will serve as proof that you are no longer financially responsible for the particular student loan.

Additionally, you will receive a Cancellation of Debt notice (a 1099-C) at the end of the year.

A 1099-C is also sent to the IRS and represents the unpaid portion of your student loan as income. You’ll need to file this with your tax returns and will likely need to pay income tax on that amount.

Does settling student loan debt hurt your credit? Settling student loan debt may hurt your credit and FICO score. Lenders understand that settlements happen after delinquency and default, and the settlement will be on your credit history for years to come.

The student loan balance will be zero on your credit report, but the status will show you settled the account for less than the full amount.

However, other options like a judgment or collection can have an even greater impact on your credit. And a student loan can’t be settled until you’re already in default, which is far more of a drag on your credit score.

This is one reason it’s essential to consider all of the factors in your individual case — and ask an expert.

Alternatives to student loan settlements

If coming up with at least half of your loan balance isn’t feasible, you still have options to get out of your student loan concerns and get back to living your life.

The first option is to enter a repayment plan with your lender. A private lender isn’t required to provide student loan repayment options for borrowers in default, but federal student loans allow repayment plans.

Once the payment plan is complete, the loan is considered current, and the default status will be removed from your credit report.

Another option is to refinance or consolidate your defaulted student loan. These options may allow you to get a lower interest rate and/or monthly payment. Rehabilitation (available to federal student loan borrowers) can suit some borrowers with defaulted student loans.

Need expert advice about your student loan settlement?

In most cases, hiring a lawyer is the best option to ensure the best student loan settlement opportunity while protecting yourself.

I can help you decide if settling your student loans is the best option for you. Schedule a free 10-minute call with me today. We’ll go over possible settlement options and any alternatives that fit your needs and goals.

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I'm a student loan lawyer that helps people like you with their federal and private student loans wherever they live.

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