Is It Possible To Settle Student Debt For Less Than You Owe?

Can you settle your student debt for less? Maybe.

The idea of settling your debt may seem pretty alluring. Just think of the payments you wouldn’t have to make, the interest that would no longer accrue, and the stress you’ll save yourself if you
could just be rid of your student loan debt. However, settling your student loans can only be achieved in rare cases.

First of all, the only time you can settle your student debt is if you are in default. In some cases, you can settle while you are severely delinquent but not yet in default, but that is much less common (even settling any debt is pretty uncommon to begin with).

But no debt collector – be it the United States government or a private company – will allow you to settle your loan for less if you have at least a reasonable chance of paying it back. You need to demonstrate that you are unable to pay by defaulting, and that usually means you are sent into collections.

Once you are in collections, you can contact the collections agency or the owner of your loan and ask if you can negotiate a settlement. If you have federal loans, you can contact the Department of Education, but they might refer you back to the collections agency or the agency guaranteeing your loan.

In extremely rare cases, the owner of your loan or the collections agency might initiate a settlement offer. There’s a good chance any settlement will have to be paid in a lump sum.

If you're not quite sure where to start or what to do, consider hiring a CFA to help you with your student loans. We recommend The Student Loan Planner to help you put together a solid financial plan for your student loan debt. Check out The Student Loan Planner here.

Is Settling Even A Possibility

If your loans are in default, it probably means you don’t have a big lump sum lying around to give over as a settlement, even if it was less, right? That’s likely true for most people. But some people might be in default and have other finances pending, like an inheritance or a gift or a loan from a family member. For those who don’t, a settlement still might be their best bet to resolve their loan issue — a few settlements may include the option to repay in installments - which could be less that your monthly payments over time.

This decision to settle your loans is unique to each person’s financial situation. You have to break out the calculator to make sure you are getting the best bang for your buck with a settlement — taking in mind how much you are paying in collection fees, interest, and the principal. Hiring a private debt settlement negotiator or a lawyer might help you negotiate better, but you will be shouldering the cost of their services as well, and their fees might be steep.

It’s important to note your options for debt settlements for federal student loans and private student loans are different.

Settling Federal Student Loans

While you can technically settle your federal loans — whether they are FFEL or Direct Loans that are in default — it’s highly unlikely that you will be able to. Why? Federal loans are money owed to the U.S. Taxpayer. As such, Congress sets the rules by which you can settle, and there are just too many ways the US government can collect from you once you’re in default.

They can garnish your wages,  take your tax refunds, garnish your Social Security, or go after other federal benefits. They don’t need court approval to begin wage garnishment, either, like private loan owners do.

In fact, the Department of Education issues no public guidelines on settling federal loans because they do not want to encourage anyone to do so.

However, the Education Department does issue internal guidelines to their contracted collection agencies and guaranty agencies. (Guaranty agencies are organizations that guarantee FFELP loans against default and often service them as well, like AES.)

This Department of Education guideline memo to guaranty agencies from 1993 states that guaranty agencies are permitted to “compromise” or settle the loan under certain conditions and up to certain amounts.

Those allowable settlement or compromise offers are:

1. Waiver of debt collection fees
2. 50% waiver of interest and fees
3. 90% of principal and interest

But say you do decide to go this route, you have to be ready with a good offer to negotiate with the collection or guaranty agency. FinAid.org suggests calculating to make sure your offer is at or more than what they would get if they kept garnishing. Having a couple of counter-offers ready to go is also a wise decision.

Settling Private Student Loans

Debt settlement is more common with private student debt, though not quite as common as settling other kinds of debt. Collections on private loans cannot tap into your tax returns, Social Security benefits, or other kinds of federal benefits. (If any collection agency of private loans tells you this, they’re lying to scare you.) They also must go to court in order to garnish your wages.

However, settlement of student loans is less common than other kinds of debt because it is not dischargeable in bankruptcy (except in extremely rare cases). Once again, this is because a student loan's collateral is your earnings, and you'll have to prove that you'd never be able to earn enough to pay back the student loans ever - which is a very high bar.

However, there are statutes of limitations on private loan collection. The rules vary state-by-state, but in general after a certain amount of years (usually between 3 and 10 years), your collector can no longer begin litigation against you. While they can still attempt to collect from you in other ways, they can't take you to court. This means they can't begin garnishing your wages or place liens on your property. After the statute of limitations runs out, your debt is less likely to be collected and your chances of a favorable settlement are usually higher. However, this is not an easy path to settlement. Litigation could pop up at any time before the statute expires or you could unwittingly re-start the clock on the statute depending on state law. There are also no guarantees on your settlement outcome.

Each private lender has its own policies on settlements. You could potentially settle for less than half the amount you owe. Before contacting the collections agency or lender to negotiate a settlement, you might want to consult with a student loan lawyer so you don’t make things more difficult for yourself with an unknowing mistake.

Know that settling for less is still very low on the list of desired outcomes for a collector or owner of a debt. Again, if you do get a settlement, you are often required to pay the settled amount in a lump sum.

Strategic Default To Get A Settlement

Some people consider defaulting strategically for the purpose of settling their loan. While this may be a strategy towards success if everything goes right, you could easily wreck your credit, open yourself up for litigation from your lender, and not even get want you want out of your settlement deal.

You could accrue fees and interest along the way. And you may still be stuck with the loan in the end. This is definitely more of an option for private loans, but certainly not one we recommend.

In fact, we've read some horror stories in our student loan forum from people who've attempted this as a recommendation and ended up in a much worse financial situation.

Evaluating All Your Options

However, we suggest considering other paths to manage your student loans. If you have federal loans, the good news is that they have better protections and options for borrowers to prevent default, like income-driven repayment plans and forgiveness programs.

If you do default, which is a reality for about 11% of student loan borrowers, the federal government offers default rehabilitation and consolidation to resolve the issue without pursuing settlement. 

Private loans are a bit trickier because they don’t come with the protections federal loans do. But if you’re not yet in default, we strongly urge you to contact your lender and find out what your options are before you decide on settlement. We also recommend looking into refinancing if your current loan terms are not going to work for you.

If you're not quite sure where to start or what to do, consider hiring a CFA to help you with your student loans. We recommend The Student Loan Planner to help you put together a solid financial plan for your student loan debt. Check out The Student Loan Planner here.

All in all, a settlement is a rare solution for the rare borrower. We recommend pursuing it only after careful consideration.

Would you ever consider a student loan debt settlement? Why or why not?