Student Loan Settlement: Are You Eligible to Pay Less Than You Owe?

With more than 1 in 10 student loans either delinquent or in default, many borrowers are looking at student loan settlement as a potential solution. After all, a successful negotiation could leave you paying less than what you owe to become debt-free.

Student loan settlement could be wise in extreme cases, however, such as when:

• You’re already late on your monthly payments
• You have the ability to make a lump-sum payment without sacrificing your finances
• You wouldn’t be better off opting for alternative strategies

Here’s what to know before you start debt settlement negotiations, as well as some other possibilities if it isn’t right for you:

When student loan settlement is a realistic option

Your ability to negotiate your student loan debt will depend largely on whether your loans are federal or private. One thing that both have in common is that the loan must be in default.

“No one can settle on a working loan,” said Joshua Cohen, attorney and founder of thestudentloanlawyer.com.

Still, with millions of borrowers in default, such negotiations aren’t that uncommon. Here’s when they’re an option:

Federal

• The loan is in default. Before you can even start to negotiate on a federal student loan, Cohen said your loan needs to be in default, usually meaning it’s at least 270 days (about nine months) past due.
• You have a lump sum to make the settled payment. According to Cohen, when you negotiate a federal student loan debt, you must pay the negotiated amount as a lump sum within 90 days.

Private

• The loan is in private student loan default. Like federal loans, private loans must usually be in default to negotiate. But according to Cohen, private loans are often placed in default after they’re only 90 to 180 days past due.
• The loan has been charged off and is in collections. Once a loan is far enough past due, the debt is charged off and sent to a collection agency. As Cohen said: “Private loans are much like credit cards. You still have to default, and after four to six months you are charged off, meaning deemed uncollectable. (Lenders) can still come after you though.”
• You have a lump sum to pay for it. As with federal loans, you’ll generally want to be ready to pay a negotiated private loan debt with a lump sum payment. You may be presented with the option of a payment plan, but Cohen advises people to think twice before accepting these: “With private loans, many debt collectors will offer a payment plan, but that’s a trap.” This is because the collection agency might transfer the loan to a different collector before the plan is done, and you would have to negotiate a new deal from scratch, he said.
• Waiting out the statute of limitations likely isn’t viable. Many states have a statute of limitations for debt, after which the debt becomes unenforceable. Sometimes, though, this would involve dodging collectors for years. Also note some actions can “reset the clock” on the statute of limitations date — “In the most consumer-friendly states, you have to actually make a payment to reset the statute. But in some states, just acknowledging the debt resets it,” Cohen said. Check your state’s statute of limitations.

How to get a student loan settlement

Here’s a step-by-step walkthrough of how (ideally) a student loan settlement would happen:

1. Approach your lender about settling

You’ll want to open negotiations with your creditor with a polite tone. If the loans are federal, you probably won’t need a student loan attorney, since the government will likely offer you the same options regardless.

But it may be worthwhile to get legal counsel if you’re trying to settle a private student loan.

“Since you are dealing with a debt collector, you are protected by the Fair Debt Collection Practices Act, so [collectors] can only bother the lawyer, not the borrower,” Cohen said.

2. Negotiate the debt settlement

There are some significant differences between types of settlement for federal loans versus private loans. Additional differences come into play when negotiating with debt collectors.

Federal

Federal loans and those held by the Department of Education have three options used in almost all cases for settlement offers:

• Waiver of fees with payment of 100% principal and interest
• 90% principal and interest
• 100% principal and 50% interest and fees

You can find your collection agency and its contact information via StudentAid.gov.

Private

According to Cohen, private loan settlement offers will depend on the lender, but they often follow these guidelines:

• For a defaulted loan that hasn’t been charged off or sent to a debt collector: 70% to 80% of the balance
• For a loan roughly six months in default that has been charged off and is with a debt collector: 60% to 80% of the balance
• After two years with no payment: 20% off the balance

Debt collectors may offer an even lower settlement after the statute of limitations runs out.

3. Get the agreement in writing

A verbal agreement isn’t what you’re looking for when you attempt to settle student loan debt. Instead, you want the terms fully spelled out in writing through a debt settlement letter.

“Don’t pay until you get a written offer. If they say they won’t give you one, hang up and call back and get a different person,” Cohen said.

4. Pay the agreed-upon amount

Negotiated federal loans need to be paid in full within 90 days of receiving the written agreement. In most cases, unless you can negotiate a very short timeline for private loan repayment, these should also be paid in a lump sum after receiving the written offer.

Save your final statement once the lender sends it out. If they don’t send a final statement, request a letter that shows the account was settled in full. Then, monitor your credit report to ensure that the loan appears as settled and paid.

You’ll want to avoid a zombie student loan debt that stays alive longer than you want.

Downsides of student loan settlement negotiations

Student loan debt negotiation may free you from some or all of your debt, but it comes at a price.

That price used to include having to pay tax on the cancelled amount, but that’s no longer the case through 2025, thanks to the student loan stimulus relief passed by Congress in March 2021.

Still, there are a couple of other repercussions you may face upon settling:

• It can impact your credit score. Despite settling a student loan, your credit history and score will still reflect the delinquency and default for seven years — though you can negotiate with your lender or loan servicer to mark your debt as current and paid up, if not in full.
• Settlement might wipe out your savings. Federal loan settlements must be paid at once, and it’s a good idea to do the same with private loans. This isn’t easy for many borrowers and could wipe out your savings. And as Cohen advised: “If [making the payment means you] don’t have enough money for groceries, then you really shouldn’t have paid the lump sum.”

When you can’t settle student loan debt

Being current on your loan is one factor that would erase your eligibility for a student loan settlement. Here are three more scenarios where settling might not be possible.

1. You’ve deliberately defaulted on your loans just to settle

Also called “strategic default,” this is a form of fraud that can land you in bigger trouble. By holding off on your payments, it sends the message to your lender that you’re forcing them to settle.

If you hold off making your payments and become delinquent with the intent to go into default on purpose, you’ll lose the chance to settle, and you’ll still owe your entire balance as interest continues to accrue.

2. A court judgment has already been issued against you

Once lawsuits have been filed, judgments have been made, and you’ve been ordered to pay your lender what you owe, it’s too late in the game to request debt settlement.

3. You’ve come into a disproportionately large sum of money

Lenders won’t typically approve a settlement if you have enough cash to make your loan payments or pay your debt balance in full.

If, for example, you received an inheritance, won the lottery or received another type of financial windfall, it’ll be more difficult to prove the hardship necessary to seek out a debt settlement to begin with.

Alternatives to student loan settlement

Student loan settlement, especially when it requires a large lump-sum payment, isn’t an option for everyone. Some alternatives include:

1. Negotiating a repayment plan

Private student loan lenders who don’t want your loan to go into arrears or be charged off may agree to a new plan that lowers your monthly payments. Contact your lender directly to find out what they can do. Still, some may be unwilling to negotiate a new repayment plan unless your loan is in default.

2. Income-driven repayment plans

When your income isn’t enough to service your federal student loan debt, you may qualify for an income-driven repayment plan, or IDR. These plans can cut your monthly payments to an affordable percentage of your disposable income, and after a given period of time (usually 20 or 25 years), any remaining debt balance is forgiven.

There are currently four options for income-driven repayment:

• Pay As You Earn Repayment (PAYE)
• Revised Pay As You Earn Repayment (REPAYE)
• Income-Based Repayment (IBR)
• Income-Contingent Repayment (ICR)

If lowering your payments isn’t enough to remedy your situation, you could look into pausing your dues via deferment or forbearance.

3. Student loan forgiveness programs

There are several federal student loan forgiveness programs that can wipe out a portion of your remaining student loan debt if you qualify. It’s wise to continually check eligibility criteria. Some programs — such as Public Service Loan Forgiveness (PSLF) — are notoriously hard to qualify for.

Also note that there are programs to pay back a portion of your loan, even if you don’t get full forgiveness. These are called loan repayment assistance programs (LRAPs), and they vary by location, profession and other factors.

4. Student loan refinancing

Refinancing a student loan swaps your current debt for a new (private) loan. This offers the chance to snag a lower interest rate, as well as to change the term (time length) of the loan. By refinancing, you could save a lot of money, but you’ll need either a strong credit history or a creditworthy cosigner.

But with federal loans, refinancing can sometimes be a mistake, since you’ll lose your federal loan benefits like IDR plans and forgiveness options. There may be a point to refinancing federal student loans if you have the money to pay the loan off quickly, but think it through before rushing into things.

5. Bankruptcy or discharge

If you were defrauded by a for-profit school or if it closed right after you graduated, you could be eligible to get your debts discharged (wiped away) through the borrower defense to repayment rule.

Unfortunately, student loan debt is usually not dischargeable under Chapter 7 or Chapter 13 bankruptcy, at least under current regulations, but Cohen said that there are times when it can be done.

“Bankruptcy can help even if it doesn’t offer a full discharge, because you can argue undue undue hardship.”

To prove hardship, a borrower needs to show the bankruptcy court that they have an ongoing financial situation that prevents them from maintaining a minimal standard of living if they continue paying the loan, and that despite this they’ve made a good faith effort to pay.