Negotiating a student loan payoff allows you to settle your debt for less than the amount you currently owe. There's one catch: you have to fall behind on payments and damage your credit score before settlement becomes an option.
Student loan settlement is possible, but a settlement for pennies is unlikely. Depending on whether you're looking to negotiate a payoff for federal student loans or private student loans, you're going to need a significant amount of cash for a lump sum settlement or enough money to make monthly payments over a short period of time.
In this post, I'll cover what to know before negotiating a student loan debt settlement, as well as some alternatives if it doesn't make sense for you.
Disclaimer: Although I am a student loan lawyer, this article contains general information and should not be taken as legal advice. If you want legal advice that pertains to your specific situation, you should schedule a free 10-minute consultation with me.
What is a student loan settlement?
A student loan settlement is when the loan holder agrees to accept less money than you currently owe after you've missed payments for several months.
There are three types of student loan settlement options:
- Lump sum settlement - you make one large payment to settle the outstanding balance for less than what’s owed. You usually get the biggest discount with this type of settlement agreement.
- Monthly payment - you agree to make payments over several months up to a handful of years. If you miss a payment, the settlement offer is canceled and you owe the full loan amount minus any payments you’ve made.
- Lump sum plus monthly payment - you make an initial lump sum payment and then make installment payments until the reduced balance is paid in full.
Most federal student loan settlements are for a lump sum because you typically have to pay the settlement amount in three months or less. The type of settlement you're able to negotiate for a private student loan depends on the collection agency, the loan holder, the age of the loan, the loan balance, etc.
Can you negotiate a lower payoff amount on a student loan?
You can negotiate a lower payoff amount on a student loan, but your account has to be in default or charge off status. If you're still making monthly payments or are in deferment, forbearance, or past due but not in default, settling student loan debt will be impossible.
Calling your loan servicer and asking for a discount if you immediately pay your outstanding loan balance in full won't work.
A student loan is an investment. The longer you take to pay it back, the more interest accrues, and the more money goes to the investors (the Department of Education or private companies) that own your loans.
Only when the lender stops receiving payments and the loans become severely delinquent does a settlement become an option.
- Will private student loans settle for less? Borrowers may be able to settle private student loans after the loan defaults or is charged off.
- Can federal student loans be settled? Federal student loan settlements are possible if the loan is in default and has been moved from the loan servicer to a collection agency. Federal law allows Direct Loans, FFEL Loans, and Perkins Loans to be settled, for less than the full amount. A settlement offer for federal debt is called an “offer in compromise”. Read more about student loan compromise.
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 charges 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 your loans are in good standing is one reason why borrowers consider a strategic default. However, missing student loan payments isn't without consequences.
Consequences of defaulting on federal loans:
- collection costs
- wage garnishment
- tax refund offset
- Social Security benefit offset
Plus, you'll lose eligibility for student loan forgiveness programs, income-driven repayment plans, and new federal student aid. Finally, your name will be listed in CAIVRS and you won't be able to borrow a mortgage from the federal government. So before you strategically default on federal student loans, make sure you know the consequences.
Consequences of defaulting on private student loans:
- negative credit reporting
- wage garnishment, bank account levy, and a lien placed on your home, but only if a student loan lawsuit is filed against you and the lender get's a court judgment against you.
Does settling student loan debt hurt your credit?
Settling student loan debt will hurt your credit rating 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.
Learn More: Remove Settlement Accounts From Credit Reports
How much money will I save by settling my student loan?
Savings for private student loan settlements vary greatly depending on the lender. Some lenders will accept 40% of the current principal and interest. Other lenders will demand 75%.
You won't save as much with federal student loan settlements.
Federal Student Loan Settlement Guidelines
The U.S. Department of Education has strict guidelines for settlement offers. The debt collector may offer:
- Standard Compromise - has three different varieties: (1) 100% of collection fees waived; (2) 50% of interest owed waived; or (3) 10% of principal balance and unpaid interest waived.
- Discretionary Compromise - you present an offer for less than the Standard Compromise amount with a letter detailing why the offer should be accepted (cancer, old age, financial hardship, etc.).
- Non-Standard Compromise - the debt collector offers you a settlement for less than the Standard Compromise amount without approval from the U.S. Department of Education.
Borrowers in default with loans made under the Federal Family Education Loan Program (FFEL Loans) that are owned by a guarantor, may agree to a waiver of 30% of your principal and interest.
However, in my experience, federal student loans almost never settle for less than 85% of the outstanding principal and interest balance.
Learn More: Student Loan Offer in Compromise
Who can help you negotiate student loans?
- Negotiate yourself. There's no law against you going the DIY route and contacting the debt collection agency that has your student debt to offer a settlement. However, be careful about resetting the clock on old private student loan debt by agreeing you owe the loans and setting up payment. Federal student loans never go away, so you don't have to worry about restarting the statute of limitations.
- Hire a lawyer. A student loan lawyer or an attorney who specializes in debt settlements can negotiate a settlement for your federal or private student loans. Hiring an attorney doesn't guarantee you a result or that you'll save you more money than if you tried to settle yourself. That said, a lawyer experienced in negotiating settlements with certain lenders, like Navient or SoFi, has a better understanding than you do of what's the best settlement offer.
- Work with a debt settlement company. Debt settlement companies help by having you stop making payments to your lender and then make payments to the company. During that time, late payments will be added to your credit report causing your credit score to drop. Once you've put enough money aside, the company will try to negotiate a settlement. But they may not be able to do so because some lenders refuse to work with debt settlement companies. Before you hire a company, ask if they've ever settled with the lender that owns your loans and, if so, how often.
How to negotiate a student loan payoff
Before you start negotiating, check with your student loan servicer to find out if your loans are near or in default. When you make contact, the servicer might offer you a forbearance or alternative repayment plan like interest-only payments for a short period.
Step 1 - Know what you can afford
Check your finances to know how much cash you can put your hands on and when it will be available to you. Look at your savings, 401k, inheritance, family members, pay stubs, and monthly expenses to learn what you can afford in a lump sum or per month.
Step 2 - Know what type of loans you're settling
Remember, settlements vary greatly depending on whether you're settling federal student loans or private student loans. If you're not sure what type of loans you have, check studentaid.gov. Any loan listed on the Federal Student Aid website is a federal student loan. If your loan isn't listed there, it's likely a private student loan.
Types of federal student loans:
- Direct Loans
- FFEL Loans
- Perkins Loans
Types of private student loans:
- National Collegiate Student Loan Trust
- Navient Tuition Answer and Signature Student Loan
- Citizens Bank Student Loan
- Younomics/MyRichUncle Student Loan
- MOHELA Cash Loan
- SoFi Student Loan
- Coronado Student Loan Trust
Also, if you have student loans with University Account Service, those loans are likely private student loans.
Step 3 - Contact the debt collector
Ask the representative for the repayment options on your defaulted loan. If they don't offer you a settlement, ask if settlement is an option, and, if so, how much will they accept. At this point, the representative may ask you for about your personal finances, marital status, etc. Try to avoid giving too much detail until you get an offer. Once you get an offer, you can either accept it or counter.
If you're unsure how to get a settlement offer, explain a summary of your situation and ask, "Given my situation, what can we do to resolve this debt as quickly as possible?"
Step 4 - Review the offer
Make sure you get the offer in writing. When you get it, review the offer to make sure:
- the loan ID numbers are listed
- your name and contact information are correct
- the settlement payment plan terms are listed (lump sum, monthly payment, payment date, etc.)
Step 5 - Pay the settlement
Submit payment by following the payment instructions listed in the settlement offer. Typically, you can make the payment using a check, money order, debit card, or using autograft. Many lenders won't let you pay using a credit card.
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'll receive a Cancellation of Debt notice (a 1099-C) from the IRS at the end of the year. A 1099-C represents the unpaid portion of your student loan as taxable income. You’ll need to file this with your tax returns and will likely need to pay income tax on that amount.
The IRS has a process that allows taxpayers to avoid having to pay taxes on the canceled amount. Speak with a tax professional to see if you qualify.
Alternatives to settling student loans
You still have options to get out of your student loan debt even if your financial situation doesn’t allow you to settle.
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 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.