Settling Your Student Loans: Watching Out for Yourself
If you’ve defaulted on a student loan, you’ve basically given up on paying it—which can land you in a lot of trouble. For federal student loans, you’ve officially defaulted when you’ve gone at least a year without paying. You can’t discharge federal student loans in bankruptcy—and even if you’re lucky enough to become one of the 1% of students in bankruptcy who actually succeed, you’ll have terrible credit for seven years. But you do have some options. One of them is settling your debt.
Settlement is an unusual option, because many students don’t have the ready cash on hand to pay off their debt in one large chunk. But if you do have the capital and qualify for a settlement, it may be a better option than a repayment plan.
Settling your debt means making a large up-front payment, usually within 90 days, that accounts for most of the balance of the loan. This is not an option within easy reach for most students—after all, if you’ve had to let your loan go into default, you probably don’t have that kind of cash lying around. Still, some students get lucky enough to collect an inheritance or get a loan from a family member. Others pay off the loan by borrowing from other sources, although commercial loan interest rates aren’t likely to be better than the rates of federal student loans.
Typically, you’ll settle your debt through a private student loan collections agency. The US Department of Education allows these agencies to make three types of settlements without getting its approval. If you want a different deal, the collection agency could lose its commission while getting approval from the US Department of Education—so compromises are rare.
The first type of settlement involves a collection charge waiver. You’ll be responsible for paying the current principal and all unpaid interest, but not any extra collection charges. This can add up to a considerable amount, as it typically amounts to 25% of each monthly payment you skipped on before you defaulted.
The second type involves payment of the current balance, as well as 50% of the unpaid interest. The third type of settlement requires you to pay at least 90% of the current balance of principal and interest.
Which option is cheapest depends on your individual situation—but the first option is usually the most affordable to students. Still, collections agencies may not offer all three. They may start off by trying to get the least reduction in interest and principal as possible. You’ll have to know the types of settlements available beforehand and do the math to figure out which is cheapest for you—depending on your situation.
Not everyone gets a settlement. Typically, a student only gets a settlement if it has been several years since the last payment and it’s impossible for the student to repay the loan any other way. In general, if you make enough to be able to afford at least a minimum monthly payment, you won’t get a settlement. But if you do manage to negotiate one, get all the terms in writing—and run them by a lawyer.
Be absolutely sure the settlement includes a “paid in full” statement after you’ve paid—otherwise, unscrupulous lenders could apply your payment to the debt without settling it in full. The debts could come back years later claiming that you never paid, and you’d have no documentation to prove otherwise.
It’s important to realize, as well, that a monthly student loan repayment plan of any kind is not a settlement. With a monthly repayment plan, you’ll still be responsible for all interest and principal, as well as—most likely—any penalties and collection charges that accrue. A settlement can be more desirable than a repayment plan, if you have the cash, because you may be able to settle your debt for less than you owe.
When you default on your student loans, you have few good options. Settlement is an unusual option, because many students don’t have the ready cash on hand to pay off their debt in one large chunk. But if you do have the capital and qualify for a settlement, it may be a better option than a repayment plan. But before agreeing to anything, it’s a good idea to consult an attorney. The collections agencies are out for their own best interests and can sometimes be unscrupulous—so you’ll need to take care of yourself or you could end up with bad credit from your student loans .
FastWeb: Secrets to Settling Your Student Loans for Less Than You Owe
FinAid: Student Loan Debt Settlements
NYTimes: Tips on Settling Defaulted Student Loans
More About Understanding Student Loans
- Credit Repair Services You Should Never Pay For
- Questions You Should Ask Before Applying for Student Loan Forbearance
- The Bank on Students Act: What It Is, and How It Could Help Student Borrowers
- How the Death of a Co-Signer Can Affect Your Student Loan
- Peer-to-Peer Student Loans: What They Are, and How They Can Help You Pay for College
- If You're Unable to Work Because of a Disability: What Happens to Your Student Loan?
- New Rules for Debt Collectors: How They Could Affect Your Student Loan
- Having Trouble Repaying Loans? The Department of Education May Be in Touch