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How to Settle Your Student Loan Debt for Less Than You Owe


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If you’ve defaulted on your student loans, the threat of debt collectors hounding you for payment, wage garnishment, tax refund seizure, legal action, and credit damage can be emotionally and financially devastating.   

Fortunately, it’s possible to settle your student loans for less than you owe. But negotiating a settlement can be tricky. 

Nevertheless, debt settlement can be worth pursuing if you’ve missed several months of student loan payments and you’re unable to repay your loans in full. 

How to Settle Your Student Loan Debt

It’s important to know which type of loan you have so you know who to contact about the settlement. If you’re not sure, check StudentAid.gov. That lists your federal loans, so if you have a loan that’s not there, it’s a private loan.


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There are differences between settling federal and private student loans. But the process follows the same general steps.

1. Review Your Options

Scrutinize your finances to see how much cash you can get your hands on when the time comes to negotiate a settlement. Whether you’re attempting to settle federal or private student loans, you need to know what you can afford to pay.

If you’re successful in settling federal student loans, the United States Department of Education (ED) requires you to pay the full amount in one lump sum within 90 days of the settlement agreement. 

Private lenders may give you more time, but you can get a better deal with a lump sum. A lump-sum settlement lowers the lender’s risk that you’ll default on the settlement installment agreement too. 

The similarities between your options end there. 

Private lenders have wide latitude when negotiating settlements, meaning they’ll do whatever it takes to get the most money possible. But federal loan settlement options are stricter because you’ve borrowed taxpayer money.

Federal Student Loan Settlement Options

Because congressional rules govern federal student loans, your negotiating power is limited. Typically, you only have access to established standard compromises:

  • A Waiver of Collection Fees. You pay the remaining principal balance and interest.
  • A Waiver of Half the Accumulated Unpaid Interest. You must pay the remaining interest and the full principal.
  • 10% Waiver. The government waives 10% of the current balance of combined principal and interest. You must pay the remaining 90%.

It’s possible to settle for a different amount through a discretionary compromise. But student loan lawyer Stanley Tate notes that in his experience, the ED rarely settles federal loans for less than 85% of the total balance.

Private Student Loan Settlement Options

You have significantly more room to negotiate with private lenders because they can do whatever they like with their own money. However, your settlement can vary widely by lender. Some may require you to pay up to 90% of your balance, while others may be willing to settle for as little as 40%.

Typically, the longer you go without making a payment, the less likely it looks that they’ll be able to collect at all. That makes lenders more willing to accept less. 

However, going years without agreeing to a settlement also puts you at greater risk of getting sued by the lender. And if they’re successful in getting a court action to garnish your wages, there’s no incentive for them to settle.

2. Gather Supporting Documentation

Ensure you know who’s managing your federal or private student loans and that they have your up-to-date contact information, including your phone number, address, and email. You can update these on your lender’s or servicer’s website.

Note that you have an obligation to repay your debt, so a lender’s inability to contact you isn’t a defense. So if you’re not sure who you’re supposed to be paying, you need to find out before you do anything else.

The government assigns a servicer to administer federal student loans. You can find out who it is by visiting StudentAid.gov.

If you have private student loans, your lender’s name is on your credit report. You can get a free copy of your credit report annually from each of the three major credit reporting bureaus by visiting AnnualCreditReport.com

StudentAid.gov or your credit report also shows the total student loan balance so you know your starting point for negotiation.

Another thing you need to know for negotiation is how much money you have to pay a settlement. But you also need to show you’re unable to repay your loan. It’s a strange catch-22.

Regardless, you must make the case you’re unable to repay your loan in full or through other methods, such as alternative repayment plans.

To make your case, collect the following:

  • Pay Stubs. Gather copies of any pay stubs and recent tax returns.
  • Bank Statements. You may have to include copies of your bank statements, especially if you’re unemployed, to prove a lack of means.
  • Health Records. If you have an illness or disability that makes it impossible to work, request a letter from your doctor detailing your diagnosis and limited ability to work.
  • Other Financial Records. If you have any extenuating circumstances that affect your finances, such as caring for a relative or ill spouse, include those records — for example, home health aide bills or hospital bills.

Note that if a collection agency ever asks you if a relative can help, tell them no, even if it’s true. No one is legally obligated to repay your debts except you. And if they know a relative can help, they’ll squeeze you for more money. If someone agrees to help, that’s just a bonus for you.

The exception is if you have a co-signer on your defaulted student loans. If you attempt to settle those loans, you must prove your co-signer is equally unable to repay them. Otherwise, the lender can just go after them for the money. 

3. Decide Who Will Do the Negotiating 

Should you attempt to negotiate on your own or hire someone to negotiate on your behalf? Your choice depends on your comfort level and the severity of your situation. 

Yourself

Some student loan debt settlement companies claim they’re the only ones who can negotiate with creditors. But the truth is you can always do it yourself.  

However, the process of student loan settlement isn’t like settling other debts. Some nuances make it trickier, especially with federal student loans, and the sheer scope of many borrowers’ debts can make it feel overwhelming. 

Thus, if you don’t feel comfortable doing it yourself, it may be worth the cost to work with a debt settlement company or student loan lawyer. 

A Debt Settlement Company

Debt settlement companies have you stop making payments to your lender and make payments to them instead. Once you’ve put enough money aside, the company tries to negotiate a settlement with the lender. 

But some lenders refuse to work with debt settlement companies. So before you pick one, ask if they’ve ever settled with that lender and if so, how often.

If you go with a debt settlement company, ensure the company is legit. Check their rating on the Better Business Bureau website or search online for customer reviews. Look for nonprofits, like credit counseling agencies. And beware of advertising that makes unrealistic promises.

A Student Loan Lawyer

Alternatively, student loan lawyers specialize in the nuances of student loans, both federal and private. 

Hiring a lawyer doesn’t guarantee you a better result than if you negotiated on your own. But they have a much better understanding of what to expect, how to talk to lenders, private student loan laws in their state, and how to make an offer.

That could make the added cost worth it. And if you get sued by your lender, you definitely want to hire a student loan attorney. 

To find one, search on the National Association of Consumer Advocates website. It’s the bar association of consumer rights attorneys, some of whom specialize in student loans. To find one, select student loans and the state where you live from the drop-down menu on its attorney directory.

If you can’t afford an attorney, search on the American Bar Association site for a pro bono student loan lawyer. Start by scrolling down to “State by State Listings” and click on your state. Then, select your county to get a list of regional pro bono organizations. 

Carefully read the descriptions to find one specializing in student loans, debt, credit, or bankruptcy.

If your state’s offerings on that website are sparse, try the Legal Services Corporation. The nonprofit funds 132 legal aid programs that help individuals at or near the poverty level struggling with many issues, including student loans. To find a program near you, visit their locator page.

4. Get a Settlement Offer

Unfortunately, you can’t negotiate a settlement on loans in good standing. They must be in default. For federal loans, that takes 270 days (roughly nine months) of missed payments. For private loans, it varies by lender, but typically default happens after 90 to 120 days (roughly three to four months) of missed payments. 

If it’s a private loan, wait for the lender to contact you. Someone will attempt to collect on your loan after you’re in default. The longer you’re in default, the more likely they are to send you an offer to settle for a lesser amount. 

If your loan has been in default for more than six months, this offer will likely come from a collection agency.

Waiting for the offer rather than making the first move gives you a stronger starting point for negotiation. You know the lender has decided they’re not getting the entire amount back and is willing to offer a settlement. 

But if you’re attempting to settle federal student loans, don’t wait. 

Since the federal government can garnish your wages, seize your tax refunds and Social Security benefits, and even reach into your bank account without having to sue you first, they aren’t likely to make an offer at all. And since the available settlement terms are set by law, you only have a handful of choices, anyway.

5. Negotiate the Settlement Terms

If you have private loans, compare the offer you receive with your ability to pay. If they ask for more than you’ve got, you can make a counteroffer. Let them know what you’re able to pay. 

But note that lenders generally won’t accept less than 50% of what you owe. Even then, they’ll expect a lump-sum payment for a discount that steep. 

You also need to substantially prove that if they attempt to sue you, they won’t be able to collect more. This is where that documentation you collected comes in. Explain that you defaulted for financial hardship, and submit your paperwork for the lender’s review. 

When it comes to settling federal student loans, the road is difficult. Federal loans are rarely settled because there are repayment options to help you get them out of default, particularly for struggling borrowers. These avenues include consolidating your loans and repaying them under an income-driven repayment plan

However, if you’ve already defaulted on your loans once and gone through the process of student loan rehabilitation (make nine on-time monthly payments), you may be able to settle them since you can only rehabilitate your loans once. 

You may also be able to settle your loans if you can prove you can’t pay the balance in full but have a large enough lump sum to pay most of it. Remember, the least the ED usually settles for is 90% of the balance, and you must pay the total settlement amount within 90 days of the agreement. 

If you can only pay 85%, you can write a letter to the ED asking for a discretionary compromise. Your letter must detail why you need to settle for less than 90%. For example, you’re ill and unable to work.

But even then, the ED is unlikely to agree. That’s because there are too many other options for federal student loans. 

For example, if you’re unable to work due to illness, you can receive a forbearance. And if it’s due to cancer, the government will even waive the interest on subsidized federal student loans during treatment. 

And if you’ve lost your job, you can enroll in an income-driven plan and make $0 “payments” that count toward eventual forgiveness of the loan balance after making the required number of payments, whether under the standard student loan forgiveness program or public service loan forgiveness.

6. Review the Settlement Agreement

Once you’ve reached a settlement agreement, get it in writing. Even if you’ve negotiated the terms on your own thus far, at this point, it’s best to have an attorney review the contract. 

The terms of the offer should include:

  • A Final Statement Indicating You’ve Paid Your Debts in Full. This statement protects you if the lender ever tries to collect the remainder of the loan. 
  • An Agreement to Report the Settlement to the Credit Bureaus. Once you’ve paid your settlement in full, your lender should update your credit report indicating that your loan is no longer in default and was “paid as agreed” or “settled in full.”
  • The Loan ID Numbers of all the Loans You’re Settling. Ensure your agreement includes all the loans you’re settling. Each should be specifically listed with an ID number.
  • The Settlement Payment Plan Terms. Are you paying a lump sum or by monthly installments? What are the due dates? When is the final payment? Will the payments be auto-debited? The contract should outline each detail.
  • Your Contact Information. Is your name, address, and phone number listed and correct?

Keep this contract in a safe place until the settlement is complete.

7. Pay the Settlement Amount

Submit payment to the lender or servicer according to your settlement agreement. Typically, you can pay using a check, debit card, or autopay. Most lenders refuse credit cards.

Whether you agreed to a lump sum payment or monthly installments, if you don’t pay by the due date or miss any of the monthly payments, it voids the settlement agreement. 

As a result, you’ll once again be in default, and you’ll owe the full balance due plus any additional accumulated interest and collection costs.

To avoid any error, ensure you get a receipt (a letter or email) confirming payment. And keep records of all your communications with the collection agency and lender, including confirmation of the payoff date.

8. Get a Paid-in-Full Statement

Once you’ve finished paying the settlement, ensure you receive a paid-in-full statement. This statement serves as proof you’re no longer financially responsible for those particular student loans. 

Receiving this statement should have been part of your contract terms. If you don’t receive it, you could still be on the hook for the rest of your loan balance.

Keep your paid-in-full statement in a secure place for a minimum of seven to 10 years in case lenders or debt collectors try to request money from you later. You might also need it to update your credit report or tax records. 

Note that seven to 10 years is the length of time it takes for the statute of limitations to run out in most states and for the adverse history to fall off your credit report. After these two things happen, the lender can no longer sue you to collect, and you no longer need to worry about any negative marks on your credit report.

9. Check Your Credit Report

Reporting the settlement to the credit bureaus should also have been part of your settlement agreement. Ensure that happened by checking your credit reports with the three major credit reporting bureaus: TransUnion, Equifax, and Experian. 

If all happened as it should have, your loans should no longer show as defaulted or charged off. Instead, the status should read “paid as agreed” or “settled in full.” And your student loan balance should be zero.

Note that even though you’re no longer in default, a settlement still counts as a negative mark on your credit history. It will remain on your credit report for seven years from the date of your final payoff (not the date of the original agreement). 

If you see any issue with how the lender reported the settlement, you may need to contact the lender or collection agency. In the meantime, you can dispute the issue with the credit bureaus.

10. Pay Taxes on the Canceled Amount

The last thing you want to deal with after settling your student loans is a huge tax bill. After all, you likely found yourself in this situation because you couldn’t afford to repay the loans.

But some canceled debt is taxable. That means you must pay taxes on any amount canceled, forgiven, or discharged outside specific qualified federal programs. The IRS considers it income. Fortunately, you only owe taxes on the unpaid portion of your original loan balance.

So ensure you’re prepared to pay the IRS when the time comes. Otherwise, your student loan debt could turn into tax debt

You’ll receive a 1099-C from your lender showing the canceled debt amount. File the form with your tax returns for the year in which your debt was discharged.

Note that some student loan borrowers may be able to avoid paying taxes. If you are financially insolvent, defined as having total debts that exceed your assets, the IRS allows you to exclude the forgiven debt from your income taxes. 

Consult with a tax professional to determine whether or not you have to pay income taxes on your canceled student loan debt.


Final Word

Settling student loans isn’t an easy process. I know this first hand. And dealing with debt of any kind can be stressful. But once you’re through to the other side, you can begin the process of rebuilding.   

To start repairing your credit, look into a credit monitoring service like Credit Karma or Credit Sesame. These services keep an eye on your credit score and give you helpful tips on how to improve it.

Once you’ve improved your credit score, you’ll be financially set up to reach the life goals you went to college for in the first place, like buying your dream home.

Sarah Graves, Ph.D. is a freelance writer specializing in personal finance, parenting, education, and creative entrepreneurship. She's also a college instructor of English and humanities. When not busy writing or teaching her students the proper use of a semicolon, you can find her hanging out with her awesome husband and adorable son watching way too many superhero movies.

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