Negotiating and Settling Defaulted Student Loans

Defaulting on student loans can be really stressful and damaging to your finances. But there are options for getting your loans back in good standing through negotiating a settlement with your lender. This article will walk through when loan settlement makes sense, how to approach negotiations, and key strategies for getting the best deal.

When Student Loan Settlement is an Option

In most cases, only defaulted student loans can be settled or negotiated^[1]. Defaulting can have very serious consequences including penalties or fees, negative credit reporting, collections and litigation. So you don’t want to purposely default just to get a settlement. But if your loans are already in default, settlement may help resolve the situation.

Federal Student Loans

Federal loan settlements are possible, but they’re extremely rare^[1]. That’s because federal student loans are difficult to discharge in bankruptcy, and loan servicers can take aggressive measures to collect payments. But it is possible to settle federal loans that are in default^[2]. The settlement would have to be in a lump sum, and federal guidelines limit how much of a balance reduction you can get through a settlement involving defaulted federal student loans. In many cases, this results in only a marginal benefit.

Private Student Loans

Settlements for defaulted private student loans are more common because these lenders don’t have the collection leverage of their federal counterparts^[3]. A private loan holder may accept a settlement in order to recoup some money rather than get nothing if you file bankruptcy.

When Lenders May Consider Settlement

Federal and private student lenders will require your loans to be in or near default to start settlement negotiations^[4].

• Federal student loans enter default after 270 days of past-due payments.
• Timelines vary for private student loans, but default often occurs after 90 days of missed payments, according to the Consumer Financial Protection Bureau.

Some other situations where a lender may be open to settlement include:

• You are facing significant financial hardship and can’t afford payments.
• You are not eligible for additional forbearance or deferment on your federal loans.
• The lender doubts they will ever be able to collect the full amount owed.
• The loans have been sold to a collection agency and they want to get something rather than nothing.

How Much Settlement Could Save

Private student loan debt settlement amounts vary greatly. Experts say some lenders may not accept less than 80% of the total owed, whereas other lenders will take less than 50%^[3].

For federal loans, there are limits on how much reduction can be offered for defaulted loan settlement. One expert said federal guidelines limit balance reductions to 15% principal and all collection costs for loans under $50,000. Over $50,000 the reduction limit is 25%^[2].

The amount of savings comes down to negotiating and how much the lender is willing to accept. You may be able to settle for a lower percentage if you can pay a lump sum upfront rather than a payment plan.

How to Negotiate a Student Loan Settlement

Here is a step-by-step walkthrough of how (ideally) a student loan settlement would happen^[5]:

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.
2. Make your case – Explain your financial situation and hardship that makes it difficult or impossible to repay the full amount owed. Provide documentation to back up your case.
3. Get settlement terms in writing – Before sending any payment, get written documentation from the lender confirming they will consider the debt settled for the agreed upon amount.
4. Send payment – Once terms are in writing, you can send your lump-sum payment or set up a payment plan.
5. Get documentation when settled – When the payments are complete, the lender should send you documentation that the debt is settled and your loan balance is $0.

This process provides protection in case there are any disputes down the road over whether the amount was agreed upon. Get everything in writing upfront before sending payments.

Strategies for Negotiating a Good Settlement

Here are some key strategies to improve your chances of getting the best possible settlement on defaulted student loans:

• Gather documentation – Put together information on your income, expenses, and inability to repay the full amount. This supports your case for hardship.
• Know the totals – Calculate how much you owe on the loans, including any fees. Also determine what is the least you can reasonably pay in a lump sum or installments.
• Be persistent and polite – Negotiations may require some back and forth before reaching an agreement. Remain calm and professional.
• Use competition – If you have multiple loans, mention better offers from other lenders to see if they will beat it.
• Pay lump sum – Offering to pay in one lump sum rather than installments can help you get a better settlement.
• Consult an attorney – For complex cases, working with a student loan lawyer can help negotiate the best deal.

The most important thing is gathering documentation that makes a strong case for your financial hardship. The better your case, the more leverage you have to negotiate a favorable settlement.

Alternatives to Student Loan Settlement

While student loan settlements can be helpful, they’re not for everyone. If you’re in default or are in danger of falling behind on payments, here are some other options to consider^[1]:

• Loan rehabilitation – For federal loans, this involves making 9 on-time payments over 10 months to get your loan out of default. This removes defaults from your credit report.
• Deferment or forbearance – Get temporary postponement of payments if you meet eligibility criteria due to financial hardship or further studies.
• Income-driven repayment – Federal repayment plans like PAYE and REPAYE base your monthly payments on your income and family size.
• Consolidation – Combining multiple federal loans into one new loan with lower monthly payments.
• Discharge in bankruptcy – In rare cases, you may be able to get certain private student loans discharged through bankruptcy.

Before pursuing settlement, make sure you understand all the options based on your specific loan situation. An expert can help you pick the relief strategy likely to best improve your finances.

The Bottom Line

Negotiating a student loan settlement can help resolve defaulted loans but usually requires serious delinquency first. For both federal and private loans, being far behind on payments gives you leverage to potentially settle for less than the full balance. Make sure to document hardship and get any agreements in writing before sending payment. Settlements provide an option but also consider alternatives like rehabilitation, deferment or reasonable long-term repayment plans. With the right approach, you can negotiate the best outcome and avoid the damaging impacts of staying in default.