If you’ve defaulted on your federal student loans, you may have already started receiving phone calls from debt collectors.
Not only can the collection agencies hurt your credit by reporting the past-due account to credit bureaus, but they can also charge you collection fees, garnish your wages, withhold your tax refund and offset your Social Security benefit payments.
While bankruptcy is generally off the table as a solution — less than 1% of people who file for bankruptcy succeed in getting all or part of their student loans discharged — you may be able to settle with the collection agency for less than what you owe.
Student Loan Settlement Options
Student loan collection agencies can offer three settlement options to borrowers of federal student loans without prior approval by the U.S. Department of Education:
- Waiver of collection charges: With this option, you will have to pay only the principal and accrued interest on your loans. Collection charges can add up to 25% to the loan payoff amount, so this option can yield significant savings to the borrower.
- Waiver of half of the accrued interest: You will be on the hook for the full principal amount but only half the interest that’s accrued since your loans went into default. If you’ve been in default for decades, this option may save you more money than a waiver of the collection charges.
- Reduce the loan balance by 10%: You will need to pay only 90% of the current principal and interest amount.
If you’d like to request a lower settlement than these options, the collection agency will need to seek approval from the U.S. Department of Education.
How to Settle Your Student Loan Debt
Paying less than what you owe sounds like a great deal, but these options come with a significant caveat: to qualify, you need to make a lump sum payment for the full settlement amount, typically within 90 days.
If you can afford to make the lump sum payment, it may be in your best interest to settle and avoid further collection attempts and court involvement. Speak with the collection agency about your options. Also, request a copy of the settlement offer in writing plus a statement that the debt has been paid in full after you’ve made the payment.
With these documents, you don’t have to worry about the unpaid debt coming back to haunt you.
Ask a qualified attorney to review the settlement offer before you sign it. The attorney will confirm that the settlement offer settles all of the loans you think will be settled and that you will receive a paid-if-full (PIF) statement after the settlement is paid.
If you’re having a hard time getting the collection agency to agree to settle, contact the U.S. Department of Education’s Default Resolution Group for assistance. Also, consider reaching out to the Federal Student Aid (FSA) Ombudsman. While the FSA Ombudsman may not directly get involved with the settlement discussion, it can help give you some insight into the situation.
Should You Try to Settle?
In general, it’s best to go with the option that will save you the most money. If you can afford the settlement payment, you’ll get a discount on what you owe.
And while the amount of the debt the collection agency cancels as part of the settlement may be considered taxable income for the year, those taxes may still be less costly than paying interest over the next 20 to 25 years on an income-driven repayment plan.
If you can’t afford to pay the settlement amount in a lump sum, consider requesting a different payment plan. This option doesn’t include a settlement and may require you to rehabilitate your loans first. The rehabilitation process involves making at least nine full and voluntary on-time payments over 10 consecutive months.
Keep in mind that payments made through wage garnishments or an offset of your tax refund don’t count as voluntary. Once you meet the qualifications, you may be able to get on an income-based repayment plan, which can provide you with a more affordable monthly payment going forward.
Regardless of what you end up deciding, it’s important to start taking steps in the right direction. Ignoring the debt won’t make it go away, and by taking a settlement offer or rehabilitating your loans, you can prevent an already bad situation from getting worse.