What is student loan debt settlement?

You may be able to settle your student loan debt for less than you currently owe

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Student loans are some of the biggest debts most people take on, with a seemingly endless payoff schedule. However, for a select number of borrowers, student loan debt settlement is an option to finally eliminate this debt. 


Key insights

  • Settling student loan debts involves negotiating with your lender or collection agency, often with the help of lawyers or debt settlement companies.
  • While your credit score will likely take a hit, settlement can help you avoid default and clear your debt once and for all.
  • Other options, like income-driven repayment plans, consolidation and refinancing, work for most borrowers.

How student loan settlement works

“A student loan settlement is when a borrower settles their student loan debt for less than the total balance owed,” explained Andrew Lokenauth, a chief financial officer who works with technology startups. “The lender agrees to accept a lump-sum payment that is less than what was originally owed. In exchange, the lender considers the loan paid in full.”

Technically, you can settle private and federal student loans, but it’s much more likely to happen with a private loan. Federal loans offer other programs, like income-driven repayments, to help you better manage your debt.

» MORE: Student loans: reentering repayment

Who should consider student loan settlement?

Student loan settlements are relatively uncommon, so even if you’re struggling to make payments, you should never rely on this as your sole option. That said, there are certain situations in which student loan settlement may be one of the only viable options. Consider going through the settlement process if:

  • You’re facing extreme hardship. If you're unsure when you’ll ever be able to resume payments, settlement might be an option. Extreme hardship could result from job loss, medical emergencies or other unexpected financial crises.
  • Your student loans are in default. If you've missed payments for an extended period, your lender knows you likely won’t make payments any time soon and may be more willing to negotiate a settlement to recover at least a portion of the debt.
  • You’ve tried other relief options. Student loan settlement is generally considered a last resort. Exploring other alternatives like income-driven repayment plans, loan consolidation or refinancing is highly recommended before pursuing settlement.
  • You have a low income. If you work in a low-income field and have high student loan payments, it may not be feasible to keep up with these payments. In such cases, settlement may be an option.

» MORE: How to get out of debt

How to settle student loan debt

Settlement isn’t an easy process, and it should be navigated carefully to ensure you make informed decisions and limit its negative financial impact.

Although the process may differ slightly depending on whether or not you have federal or private student loans, here are the general steps for settling student loan debt:

1. Contact your lender

Tell the lender’s representative about your financial situation and explain that you want to consider debt settlement. Be prepared for the representative to offer different alternatives at first, and listen to what they have to say. They may inform you of available programs and options that you haven’t considered.

2. Gather necessary documentation

Your lender should tell you what documentation you need to present your debt settlement case. Documents you need will likely include:

  • Loan statements
  • Documents that show your payment history
  • Any communication with your lender in writing

3. Understand the types of settlements

Student loan settlements don’t all look the same. There are different options, each with special requirements you must meet.

  • Lump-sum settlements: You pay a reduced, one-time amount to settle the debt. This type of settlement typically won’t work with federal loans. But a private lender often wants to get at least some of its loan back and may be more open to a lump-sum settlement.
  • Structured settlements: A structured settlement is an agreement to make a set number of payments over time to satisfy the debt. These payments are smaller and more gradual than a lump-sum payment, making them easier to manage for some debtors.
  • Partial forgiveness: Student loan forgiveness is available for federal student loans in specific circumstances. Certain private lenders may also offer forgiveness, but don’t count on it.

4. Consider legal help or debt settlement companies

Debt settlement is a complicated process far beyond the average borrower’s understanding. Working with a debt settlement attorney can be beneficial, especially if you’re facing legal action because of your defaulted debt. You can find a lawyer via local American Bar Association (ABA) directories. You can also check the ABA’s site to see if you qualify for free legal help.

Alternatively, debt settlement companies can negotiate a debt settlement on your behalf, but they typically charge fees ranging from 13% to 25% of your total debt amount.

5. Negotiate

Legal representation or a debt settlement company can be extremely helpful during the negotiation process. Negotiating is intimidating, especially if you’re already in a bad situation. A lawyer can help you prove your financial hardship, which is critical to negotiating a forgiven or settled amount.

Be prepared for a lot of back and forth. Try to stay patient and persistent during this process, as it may take time to reach a mutually agreeable arrangement.

6. Ask for a receipt

Once you’ve reached an agreement, get it in writing. Ask for a receipt for the settlement amount or get a copy of your legal agreement. This document is necessary for your records and helps protect your interests in the event of any disputes or misunderstandings in the future.

» MORE: Student loans vs. personal loans

Other ways to manage student loans

If paying off your student loan debt doesn’t seem like it will ever be possible, settling your debt can be the answer. But it’s not the only option out there. In fact, it’s not even the option you’re most likely to qualify for. There are several other strategies and programs you can explore to manage your loans more effectively.

Income-driven repayment plans
If you have federal student loans, income-driven repayment plans allow you to lower your monthly student loan payment based on your income and family size. There are four different plan options to choose from:
  • Pay As You Earn caps your monthly student loan payments at a percentage of your discretionary income, typically 10% divided by 12.
  • Saving on a Valuable Education is the lowest payment option for most borrowers. Your monthly payment is based on the difference between your adjusted gross income and 225% of the U.S. Department of Health and Human Services Poverty Guideline amount for the size of your family.
  • Income-Based Repayment caps your monthly payment at about 15% of your discretionary income divided by 12. Borrowers who took out their loans on or after July 1, 2014, have their payments capped at 10% divided by 12.
  • Income-Contingent Repayment allows you to pay the lesser of 20% of your discretionary income divided by 12 or what your income-adjusted payment amount would be for a 12-year repayment plan. Payments can fluctuate annually as your income changes, ensuring they remain affordable. Any remaining loan balance is forgiven after you make 25 years of on-time payments.

These income-driven plans help those with low to moderate incomes still make monthly payments. They’re relatively easy to qualify for since each is based on income and family size. Typically, before you ever settle a federal student loan debt, you’ll need to try one of these options and see if you can afford the adjusted monthly payments.

Income-driven repayment plans typically aren’t offered by private lenders.

Public Service Loan Forgiveness (PSLF)
PSLF is a highly sought-after program because it offers full forgiveness if you meet two ultra-specific requirements: You may qualify for forgiveness if you’ve made 120 qualifying loan payments and work full-time for a U.S. government entity, a public service company or a not-for-profit organization.

You must meet both of these qualifications to earn forgiveness; even then, it’s difficult to be approved for this program. PSLF has changed in recent years, largely thanks to COVID-19. But the original PSLF program accepted just 2.2% of qualifying borrowers, according to BestColleges.com.

Refinancing
Refinancing your student loans involves replacing your existing (typically federal) loans with a new loan from a private lender. Borrowers usually do this to score a lower interest rate and make payments more affordable.

If you plan to refinance into a private student loan, be aware that you’ll lose potential federal benefits like eligibility for PSLF or access to income-based repayment options.

Deferment or forbearance
Deferment and forbearance are typically available for federal loans, but some private lenders also offer limited deferment and forbearance options. These allow you to pause or reduce your student loan payments temporarily. With deferment, your loan balance won’t continue to accrue interest. In the case of forbearance, the balance does continue to accrue interest.

These options are best for borrowers in need of temporary relief. If you lose your job or experience a natural disaster, paying your student loans likely isn’t your top priority. Those are the kinds of temporary circumstances in which deferment or forbearance come in handy.

Employer assistance
Some employers offer benefits like tuition reimbursement or student loan repayment assistance as part of their employee benefits package. If you can get it, employer assistance is extremely beneficial and one of the easiest options to use.

Some prominent companies offer these programs to their employees. Ally Financial, for instance, provides up to $10,000 in annual tuition reimbursement. Google is another big-name company offering loan assistance, providing employees with up to $2,500 per year to put toward student loan payments.

Settling student loan debt: pros and cons

Settling student loan debt is an option for certain borrowers facing serious financial challenges, but you must weigh the advantages and disadvantages carefully.

Pros

  • You reduce your overall debt once you settle.
  • Collection calls stop.
  • You may avoid defaulting on your loans.

Cons

  • Your credit score takes a serious hit.
  • There’s limited eligibility for some forms of debt settlement.
  • Forgiven debt may be considered taxable income, leading to tax consequences.

» MORE: Should you refinance your mortgage to pay off student loans?

Could your debt be reduced or forgiven? Take our financial relief quiz.

    FAQ

    What happens if you don’t pay student loans?

    If you don’t make on-time, regular payments, you risk your loans going into default. This leads to severe consequences, including damage to your credit score, potential wage garnishment and possibly even legal action.

    Is there a statute of limitations on student loans?

    There isn’t a statute of limitations on federal student loans, meaning there’s no time limit for the government to collect payment. However, the law for private lenders varies from state to state, so check in with your state’s department of education.

    Does settling student loan debt hurt your credit?

    Settling your student loan debt typically hurts your credit score. You’re not paying the full loan amount, so this reflects negatively on your score.

    Charge-off vs. settlement: What’s the difference?

    A charge-off occurs when a lender writes off your debt as unlikely to be fully repaid. This negatively impacts your credit. Settlement is a negotiated agreement in which you pay a portion of your debt to have the account closed. It also negatively affects your credit, but it resolves the debt for less than the full amount owed.

    Bottom line

    Student loan settlement can be difficult to qualify for, challenging to get through, and harmful to your credit score. For those reasons, settlement should be considered a last resort. Income-driven repayment plans, refinancing, forbearance or deferment are all better options for most borrowers.


    Article sources
    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
    1. Consumer Financial Protection Bureau, “ Can debt collectors collect a debt that’s several years old? ” Accessed Sept. 17, 2023.
    2. Federal Student Aid, “ Pay As You Earn (PAYE) Plan .” Accessed Sept. 18, 2023.
    3. Federal Student Aid, “ SAVE Repayment Plan Offers Lower Monthly Loan Payments .” Accessed Sept. 18, 2023.
    4. Federal Student Aid, “ What is the Income-Based Repayment (IBR) Plan? ” Accessed Sept. 18, 2023.
    5. Federal Student Aid, “ What is the Income-Contingent Repayment (ICR) Plan? ” Accessed Sept. 18, 2023.
    6. Federal Student Aid, “ What is the difference between a deferment and a forbearance? ” Accessed Sept. 17, 2023.
    7. InCharge Debt Solutions, “ How Does Debt Settlement Affect Your Credit? ” Accessed Sept. 17, 2023.
    8. IRS, “ Topic No. 431, Canceled Debt – Is It Taxable or Not? ” Accessed Sept. 18, 2023.
    9. U.S. Government Accountability Office, “ As Student Loan Payment Pause Ends, Income-Driven Repayment Plans May Help Borrowers .” Accessed Sept. 17, 2023.
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