If you can't make your student loan payments, you will not likely have them discharged as part of a bankruptcy proceeding—unless you can show undue hardship. Another option for your unmanageable student loan debt might be a compromise or settlement. In order to secure a student debt settlement, you'll have to negotiate with your lender or servicer, either on your own or with the help of a debt relief company. The exact requirements will vary depending on whether you're trying to settle federal or private student debt.
Key Takeaways
- Assessing your financial situation is the first step in determining your eligibility for a settlement.
- Exploring different options for student loan debt settlement can help you make an informed decision.
- Documenting the settlement agreement in writing is essential to protect your interests.
What Is Student Loan Debt Settlement?
Student loan debt settlement is a process by which your lender agrees to accept less than you owe on your student loan to close your account. For those who can't make student loan payments but don't meet the necessary conditions for bankruptcy discharge, settlement might be an option. You can pay a smaller amount and potentially set up more manageable payments.
With private lenders, student loan debt settlement depends on your lender's individual policies. For federal student loans, the United States Department of Education refers to the process as a compromise, and you normally need to be in default.
Assess Your Financial Situation
Before moving forward with the debt settlement process, evaluate your financial situation. In some cases, especially with federal student loans, you might be able to get on an income-driven plan with a more manageable monthly payment, including $0 per month.
If you're already in default with your federal or private loans, reach out to your servicer or lender to find out what their requirements for settlement might be.
Review your income and expenses, and make sure to note extenuating circ*mstances, such as a major loss of income or hardship due to medical costs or disability.
Understanding your current situation, including where your money is coming from and where it's going, can help you establish hardship.
Gather Documentation
Next, gather any documentation you have to support your case for debt settlement. Some of this documentation, if applicable, might include:
- Pay stubs
- Tax returns
- Debt statements
- Bank statements
- Medical bills
- Notice of employment change
- Medical records showing disability or some other circ*mstance
- Public records related to divorce, bankruptcy, or other situations that might bolster your case
- Rent or mortgage payments
- Expenses like child care and other recurring expenses you must pay
Explore Your Options for Student Loan Debt Settlement
Depending on the types of student loans you have, you might have different options for student loan debt settlement. Private lenders set their own rules, so you might need to contact them separately to find out what programs they offer. Some might accept a large lump sum, while others might require a new payment plan.
With federal student loans, you first have to consider whether using an income-driven repayment (IDR) plan might work as well as a settlement. In order to use an IDR plan, however, you need to make sure you're out of default. If you haven't made a payment in 270 days, your loans are considered in default.
Standard Compromise
To get out of default, you have some standard options with federal student loans:
- Pay 90% of what you currently owe (including remaining principal and interest)
- Pay the remaining principal and interest without collection charges
- Pay the remaining principal plus half the unpaid interest accrued during default
Discretionary Compromise
You can also submit your own compromise with a lower payment than the standard compromise. However, your proposal needs to be approved by the Department of Education. You can also reach out to the Office of the Ombudsman for Federal Student Aid to get more information and potentially get help figuring out what you might qualify for.
When submitting a compromise, you generally need to have a large sum of funds available, since these compromises usually involve a lump sum in place of an ongoing payment plan.
Negotiate Your Student Loan Debt Settlement
As you go through the process of negotiating your student loan debt settlement, it's important to follow these steps:
- Let the servicer or lender know you're experiencing hardship and can't pay the loan. Be prepared with documentation of your financial situation and hardship.
- Consider letting the lender or servicer suggest the first settlement amount. You can choose to reject the offer and make a counteroffer that works better for you.
- Determine whether a lump sum payment or monthly payment agreement would work best for your situation.
Get a Settlement Agreement
Once you agree to a settlement, get it in writing. Basic information that should be specified in the settlement agreement includes:
- The final amount that you will pay
- Payment terms, such as interval payments vs. lump sum
- The final date that the outstanding debt should be repaid
- A clause that indicates that you will receive a paid-in-full statement when the agreed-upon amount is repaid
Consider having a lawyer review the settlement agreement before signing it.
Fulfill the Settlement Agreement
Once you sign the settlement agreement, it's important to fulfill the terms as agreed. If you miss your agreed-upon payments or don't make the lump sum by the required date, you could be liable for the full amount again.
When you complete the terms of the settlement, insist on the paid-in-full statement, so you have it for your records and can use it in the event that someone else tries to collect on the debt.
Impact of Student Loan Settlement on Your Finances
If you go forward with a student loan settlement, you should understand the potential impact on your finances.
Impact of Student Loan Debt Settlement on Credit Scores
In general, by the time you reach the student loan debt settlement stage, chances are that you've missed payments and your credit score has already been severely impacted. A debt settlement can lower your score even further and can remain on your credit report for up to seven years.
A debt settlement will make it harder for you to get a loan later, and you will likely be stuck with interest rates on the loans you do get approved for.
Tax Implications of Settling Student Loan Debt
Depending on the lender, you might receive a Form 1099-C, which represents the cancellation of debt. If you receive this form, there's a chance that the difference between what you owed and what you paid as part of the settlement will be considered taxable income.
Can I Negotiate a Settlement Directly With My Lender?
Yes, you can negotiate a settlement with your lender or servicer. However, if you are submitting a compromise for federal student loan debt, the Department of Education might need to approve it.
How Much Does Student Loan Debt Settlement Cost?
The cost of student loan debt settlement depends on various factors, including your principal and interest, in addition to any fees that have accumulated. If you hire a lawyer or other professional to assist you, the cost will increase.
What Are the Consequences if You Don’t Pay Your Student Loans?
If you don't pay your student loans, your delinquency and/or default can be reported to credit agencies and result in a lower credit score. Private lenders can send your account to collections or sue you. For federal student loans, your wages can be garnished, your tax refund seized, and you might be unable to get other federal benefits later.
What Are Some Alternatives to Student Loan Settlement?
You might be able to talk to your lender or servicer about forbearance or deferment if you think will be able to get back on track later. For federal loans, you can also consider an income-driven repayment plan and, if applicable, use the Fresh Start program to get out of default.
Do You Need a Lawyer When Negotiating Student Loan Debt Settlement?
While you don't need a lawyer when negotiating a student loan debt settlement, it might make sense to hire one to help you review the terms and ensure that you understand what you're agreeing to.
The Bottom Line
If student loan debt is keeping you from reaching your goals, debt settlement may seem attractive. However, it can be difficult to get approved for a student loan debt settlement. Instead, it might make more sense to work with your server or lender to see if there are hardship options available. Especially with federal student loans, various IDR plans might help you avoid the need for settlement while still resulting in manageable payments.
Carefully consider your situation and run the numbers to see if settlement is truly the right path for you. Review other options that might work better for your circ*mstances, including discharge if you have highly extenuating circ*mstances.
