Student Loan Settlements

on November 16, 2016

If you are in default on your federal student loans and can afford to make a lump sum payment, you may be able to settle the defaulted debt for less than what you owe. A student loan settlement is a legal agreement that requires that the settlement amount be paid in full within a short period of time, usually less than 6 months. If you want to reduce your monthly loan payments, as opposed to paying off the debt in full, ask for loan rehabilitation and an income-driven repayment plan instead.

Borrowers will not qualify for a settlement of their student loan debt if there is a court judgment against them.

Otherwise, the collection agencies used by the federal government and guarantee agencies are authorized to accept three settlement offers without getting prior approval from the U.S. Department of Education:

  • Forgive up to half of the accrued but unpaid interest that has accumulated since the loan went into default
  • Waive the addition of collection charges to the loan balance
  • Reduce the overall loan balance by 10\\%

Some borrowers have been able to negotiate a settlement that included the waiver of additional collection charges in addition to one of the other two options.

Any other settlement offer will require prior approval by the U.S. Department of Education, which is extremely rare. The U.S. Department of Education will compare the settlement offer with the net present value of the money it expects to get in the future by garnishing your wages, seizing your federal and state income tax refunds and offsetting Social Security benefit payments. If the settlement offer is lower, it will not be approved.

Student loan settlements are available only to borrowers who are in default. Do not intentionally default on your student loans, in the hope that a student loan settlement will reduce the loan balance. Strategic default on federal student loans does not save you money, since the federal government almost never settles student loans for less than the loan balance when the loan went into default. Usually the best you can hope for is forgiveness of half of the interest that has accrued since the loan entered into default.

Borrowers who qualify for a student loan settlement usually get the money from friends and family. For example, the borrower’s parents might use money from a home equity loan to pay off their child’s defaulted student loans. But, they want to get a discount in exchange for retiring the defaulted student loan debt. The child will then make the monthly payments on the home equity loan. Not only does this settle the defaulted student loans and eliminate collection charges, but it often results in a much lower interest rate. Borrowers in default sometime get the money to pay the settlement amount from an inheritance, bonuses, winning the lottery, wedding presents or a hardship distribution from their retirement plan.

After you negotiate the settlement, have an attorney review the settlement agreement before you sign it. Make sure it settles all of the debts you think it settles. Some borrowers have discovered later that only some of their loans were included in the settlement agreement. For example, if they had both federal and private student loans, sometimes only the private loans were paid off by the settlement agreement.

Keep the paid-in-full statement forever. It is proof that you paid off the debt in full, in exchange for the student loan settlement. Defaulted loans have a tendency to resurrect themselves years or even decades later. It is very difficult to prove that the remaining loan balance was cancelled without a copy of the paid-in-full statement.

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