Can You Settle Student Loan Debt for Less Than You Owe?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been previewed, commissioned or otherwise endorsed by any of our network partners.

Written By

Updated on Wednesday, December 12, 2018

Weekend Images Inc. via iStock

If you fail to qualify for student loan forgiveness, discharge or cancellation, you might have already considered what might seem like the next best strategy: offering your lender less than what you owe and hope that suffices.

However, student loan settlement isn’t easy, and it isn’t right for every borrower.

Can you settle student loans?

Unlike loan forgiveness, no forms of debt settlement erase your balance. By settling, you’d negotiate with your lender, loan servicer or collection agency to pay a majority percentage of your outstanding dues.

You would also typically have to be in default — that is, 270 days late on federal loans, or usually 120 on private loans — to be eligible for settlement. If you’re not in default, it’s wise to consider better alternatives, such as:

  • If you have federal loans: Switch your federal loans to an income-driven repayment plan.
  • If you’ve fallen on hard times: Apply for deferment or forbearance to pause payments.
  • If you have good credit: Refinance your total education debt into a consolidated loan with a lower interest rate.

But if you’re already in default, then the short answer is yes, you can settle student loans. You’ll need a willing negotiating partner on the other side of the table, however.

When you can’t settle student loan debt

Settling student loan debt becomes impossible if you’re ineligible. Here are three circumstances that could disqualify you right off the bat:

  1. You’re attempting a “strategic default” — that is, you’re defaulting purposely in hopes of settling. It’s a risky move and could harm your credit score. Plus, your lender or collection agent will likely discover your ploy when they review your finances.
  2. You’ve already been taken to court, either by the Department of Justice or your private lender. At that point, hiring a student loan lawyer could help you review your options, bankruptcy being among them.
  3. You have enough cash to pay off your debt in one fell swoop. It’s an unlikely scenario if you’re in default, and as with a strategic default, your lender or collections agency will learn about your wherewithal to repay your debt when reviewing your settlement offer.

How to settle student loan debt

When you’re attempting to settle student loan debt, start gathering all records connected to your repayment. If you receive a threatening letter from a collection agency, for example, file it away for safekeeping.

Once you have all your documents, you might consider hiring a student loan lawyer to help negotiate a settlement or look at other options. A professional would tell you there are very different processes for settling federal and private loans.

Federal loan settlement

If you have defaulted on your loans, the government probably won’t be inclined to offer you a settlement or accept your proposal for one. That’s because it could take a variety of steps to collect your dues anyway, including:

  • Garnishing your wages or Social Security benefits
  • Withholding your income tax return
  • Revoking your professional licenses

The Department of Education (DOE) considers settlement to be a “last resort,” publishing little guidance on how to qualify.

That said, the DOE does empower its 18 collection agencies to settle or compromise on your balance, and even to waive collection fees.

Three types of standard compromises include:

  1. Pay the principal balance, plus outstanding interest, minus collection fees
  2. Pay the principal balance and half of any outstanding interest
  3. Pay at least 90% of the principal and any outstanding interest

For a nonstandard compromise of anything less — say, 70% of the balance plus interest — the agency might have to run your offer by the Department of Education. Also consider that collections agencies work on commission, so they aren’t motivated to offer discounts.

If you’re able to swing a settlement, expect to pay the agreed-upon lump-sum amount within 90 days. You might be able to repay it in installments, but you would have to do so before the end of the government’s fiscal year on Sept. 30, according to FinAid.

A good place to get started is the DOE’s Default Resolution Group, which can connect you with your collection agency. If you’re seeking clarification before pursuing a settlement, consult the Federal Student Aid Ombudsman Group first.

Private loan settlement

If you’re hoping to settle private student loans, keep in mind that your lender can’t get its hands on your paycheck or other funds as easily as the government can. It must first drag you into the courtroom.

Still, private lenders hold leverage in settlement negotiations. Knowing that your debt would be difficult to discharge via bankruptcy, they likely won’t settle for less than a significant percentage of your outstanding balance.

You could tilt the leverage in your favor if your debt is far from new. Your state’s statute of limitations for the collection of unpaid debts might have already passed, for example.

“Once the statute of limitations passes, the borrower can’t be held legally liable for repayment of the debt through the court system,” said Jay Fleischman, a lawyer specializing in education debt. “In some states, expiration of the statute of limitations is a defense to a collection action. In other states, expiration of the statute of limitations is a bar to filing a collections case.”

You can learn more about your state’s statutes of limitation in this MagnifyMoney post.

If your collection agency is receptive to a settlement, Fleischman recommends you make the first dollar-and-cents offer. This way, you control the “timing” of the process. Some experts, however, argue that you should wait to hear your lender’s initial number, especially if you’re negotiating with little experience. You could make the mistake of offering too little, or worse, offering too much.

Whether you’re looking to settle federal or private loans, keep in mind that falling short of a final agreement might not be a total failure. You and your lender, servicer or agency might at least agree on adjusting your repayment plan to make it more affordable. Then you can start to work your way out of default.

Consider the costs of student loan settlement against the reward

Knowing what you know now, student loan settlement might sound a lot less appealing. Even if you’re successful, you’ll have to go through the painstaking process of negotiating with your creditor — and handing over a significant percentage, if not all, of what you owe.

If settling your student loan debt still sounds like the best step for your situation, however, consider two more potential drawbacks:

  • It could harm your credit: By defaulting and potentially having a loan in collections, your credit report was already impacted. By settling your debt, your credit score could fall further — unless you negotiate with your creditor to report your payoff as “paid as agreed” or, better yet, to remove your late payment history altogether.
  • It could increase your income tax: Uness your remaining debt still outnumbers your assets, expect to receive IRS Form 1099-C for any settlement of $600 or more. And it never goes without saying: It’s always wise to consult a tax professional before making a decision.

If you can tolerate all that, you’re left with the main attraction of student loan settlement — zeroing out your balance once and for all.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Do you have a question?