Kat Tretina is a freelance writer and certified student loan counselor based in Orlando, Florida. She specializes…
The CARES Act federal student loan freeze has been extended to May 1, 2022, but many borrowers will still find it difficult to resume payments despite the extra time to prepare.
18% of student loan borrowers were behind on their payments before the federal loan freeze went into effect, according to the Federal Reserve.
A survey by the Student Debt Crisis Center (SDCC) before the latest extension was announced revealed that among full-employed student loan borrowers, nearly one in five said that they would never be financially secure enough to resume payments again.
If you’re among those facing delinquency or default, it may be possible to settle your student loans for less than what you owe. However, while settlements do exist, they’re rare. And a student loan settlement may not actually be as beneficial as you’d expect.
Here’s what you need to know about student loan settlements and what other options you have for managing your student debt.
In a student loan settlement, you negotiate an offer to pay your lender a lump sum of money that is lower than what you currently owe in order to fully pay off your outstanding loans along with interest, late fees, and collection charges.
If your lender agrees, the loan is marked as satisfied once you make the payment and you no longer have to make payments toward your debt.
While student loan settlements may sound appealing, Betsy Mayotte, president and founder of The Institute of Student Loan Advisors, cautions borrowers. “Most borrowers should expect to pay their loans in full as they agreed to when they signed the promissory note,” she says. “Essentially, the only good reason a lender might have to settle is if going through litigation might be more expensive than an actual settlement.”
A student loan settlement may not be realistic or even beneficial for your situation. Before exploring debt settlement, contact your lender to discuss alternative payment plan options to make your loans more manageable.
Adam Minsky, an attorney specializing in student loan law and contributor with the National Consumer Law Center, says that settlement can result in a favorable outcome — but only in very specific scenarios.
“Usually, only borrowers who are in default on their student loans can potentially negotiate a settlement,” Minsky says. “And default can have very significant negative consequences for the borrower, as well as any cosigner.”
Defaulting on your student loans is the first step in settling them, and doing so is a serious choice that should probably involve a debt settlement lawyer. Defaulting is considered a last resort because federal loan servicers can theoretically garnish your wages and take your tax refund to cover your nonpayment. With private loans, lenders also have the right to take you to court and sue you for your outstanding balances. At the very least, both federal and private lenders will send your account to collections and notify the credit bureaus, thus damaging your credit score.
Let’s have a look at the in-depth details of both federal and private student loan settlements.
Federal student loan settlements are put into two categories: standard or discretionary. The type of settlement you’re eligible for will affect your potential terms.
The possible types of settlement are:
For example, let’s say you currently owe $5,000 in principal, $2,000 in interest, and $1,000 in collection costs and fees, for a total of $8,000. Here is what you would pay under each standard settlement type:
Private loans are issued by banks and online lenders instead of the government, so they don’t have as standardized regulations as federal loans.
“Federal student loan settlements are governed by federal guidelines and regulations, which place limits and constraints on those settlements,” says Minsky. “Private student loans generally have more flexibility, but this can vary significantly depending on the specific lender involved.”
How settlements are handled and how much you can settle for is entirely dependent on your lender.
“There is no typical percentage amount, as student loan settlements can vary wildly depending on the type of student loan, the lender, the borrower’s mitigating factors, and whether the borrower has any viable legal defenses or disputes,” says Minsky.
To start the student loan settlement process, you can negotiate with your lender on your own, or you can work with a debt counselor or attorney to negotiate on your behalf.
“Borrowers should consult an attorney specializing in student loans in cases of bankruptcy or significant disputes or if there’s a chance the loan might be beyond the statute of limitations for collection,” says Mayotte.
After consulting with a lawyer, debt counselor or tax professional, you can start the settlement process by following these steps:
Settling your student loans for less than what you owe can sound great, but there are some significant drawbacks to consider.
To settle student loans, you usually have to already be in default. For federal loans, that means you’re 270 days or more behind on your payments. For private loans, it typically means being at least 120 days behind, although the exact time period may vary by lender. Missing so many payments can significantly damage your credit score, making other creditors wary of working with you.
If you successfully settle the loans, the default will be removed from your credit report. However, the account will show up as a settled debt. Settled accounts note that you didn’t pay the full amount, and they’ll stay on your credit report for seven years. Having a settlement on your credit report could make it difficult to qualify for other forms of credit.
If you settle your debt, you may owe taxes on the discharged amount since the IRS views the waived portion as income. If the discharged amount is more than $600, the loan holder will send you a 1099 form, and you’ll have to report it on your tax return and pay taxes.
Although you can make a compelling argument to your loan holder, there is no guarantee that they will agree to your settlement proposal.
“Keep in mind that the borrower is legally bound by the promissory note they signed and a lender is under no obligation to accept a settlement and can instead choose to litigate to collect,” says Mayotte.
Federal loans may be harder to settle than private loans, since the government can garnish the borrower’s wages without a court order. Private lenders typically have fewer tools available to collect on the debt, commonly relying on lawsuits instead.
Student loans settlement shouldn’t be the first course of action. If you’re struggling to make payments, there are other ways to make your loans more manageable.
“Before going into default, try to find ways to repay and work with your creditor,” says Leslie Tayne, a student loan expert and founder of Tayne Law Group. “Remember that defaulting on a student loan will damage your credit. However, resolving it can help improve your credit if done correctly.”
Federal loan borrowers that have defaulted on their loans may be eligible for student loan rehabilitation. It’s a process where you work out a payment amount with your lender and make nine payments on time within ten months.
“Before you negotiate a settlement, try to rehabilitate your federal student loan to get it out of default,” says Tayne. “If you’re able to do it, the default will get removed from your credit report, which will bring up your credit score. You can also apply for an income-driven repayment plan to get more manageable monthly payments.”
If you haven’t defaulted on your federal loans yet but are struggling to afford your payments, you can apply for an income-driven repayment plan. If approved, your repayment term will be extended and your monthly payment will be calculated based on a set percentage of your discretionary income.
Private loans don’t have the same benefits or processes as federal loans, but you may be able to get help if you reach out to your lender.
“If you have private student loans, contact your servicer to see what assistance they can offer,” says Tayne.
Some lenders have alternative payment plans or their own rehabilitation processes for borrowers experiencing financial hardships, so there may be ways to get back on track that don’t involve student loan settlements.
If you need help negotiating with your lender or coming up with a plan to repay your debt, contact a non-profit credit counseling agency for free or low-cost assistance. A debt counselor will review your situation and work with you to develop a plan to repay your loans.
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