When it comes to settlements, student loans are not like other types of consumer debt. And while it is sometimes possible to reduce your balance through a negotiated settlement, your ability to settle your student loans very much depends on the type of loan you have, and its status.
Settlements of Student Loans In Good Standing
It is generally not possible to settle or negotiate a balance reduction for student loans that are in good standing. That may seem counter-intuitive, especially if you have a good argument (such as a long-term financial hardship) that would normally incentivize a balance reduction in exchange for a lump sum settlement payment to resolve the debt. But unfortunately, most student loan lenders and servicers will simply not even entertain the option of settling a student loan that is in good standing and normal repayment. For government-held federal student loans, this is because the U.S. Department of Education does not authorize its contracted student loan servicers to accept anything other than a payment in full to resolve the debt.
Settlements of Federal Student Loans In Default
It is possible in certain cases to settle federal student loans that are in default. But defaulting has very serious consequences, including lasting credit damage, substantial collections fees and penalties, and the possibility of adverse collections activity such as wage garnishments and Social Security offsets. Moreover, federal student loan settlements typically have to be paid in a lump sum, usually within 90 days or less.
Most importantly, even for borrowers already in default on their federal student loans, federal guidelines issued by the U.S. Department of Education limit how much of a balance reduction you could even get through a settlement. While the reduction varies depending on the balance breakdown of your loan between principal and interest, and whether the loans are held by the U.S. Department of Education or a guaranty agency, in many cases a federal student loan settlement results in only a marginal reduction of the overall balance.
Despite this, it may still make sense for some federal student loan borrowers to settle their defaulted federal student loans as it still can result in savings, particularly when compared to paying out the full balance over time in installments with interest. But, you’re not going to get pennies on the dollar. In some cases, for borrowers who are in good standing on their federal student loans and then go into default, a settlement could wind up being even more expensive than what it would have cost to pay off their loans in full prior to defaulting, because of additional interest and fees that would accrue following the default.
Settling Private Student Loans In Default
In some cases, borrowers with defaulted private student loans may have much more flexibility to settle and negotiate balance reductions than they would for defaulted federal student loans. That’s because private student loan lenders determine their own settlement criteria, and there’s generally more wiggle room to negotiate. Some private student loan lenders and debt collection agencies may even allow settlements to be paid in installments over a long repayment term, rather than in a single lump sum payment. Borrowers will typically get a more favorable settlement, however, if they can make the settlement payment in a lump sum.
That said, nothing is guaranteed when it comes to private student loan settlements. No private student loan lender is required to settle, and some private student loan lenders may not settle at all, even if the loan is in default. And as with federal student loans, defaulting on private student loans can have serious consequences.
Typically, a student loan settlement does not result in the complete elimination of negative credit reporting associated with the debt. A settlement may improve a borrower’s credit, as it would show that the underlying debt was resolved, but prior negative history related to the student loan may remain on the borrower’s credit report for some time, even after the settlement.
In addition, student loan settlements may have tax consequences. Whenever a debt is settled and a portion of that debt is waived or cancelled, the borrower may have to pay income taxes on the cancelled portion of that debt. This may also impact any cosigner who is also listed on the student loan. Student loan borrowers and their cosigners should consult with a tax advisor about the potential tax implications of a settlement before proceeding with negotiations.