How to negotiate student loan debt settlement

 Student loan debt totals $1.766 trillion in the U.S., according to the Education Data Initiative. Individually, borrowers carry an average debt balance of $37,718 for federal loans or $40,499 if you include private loans. But the reality is that paying back student loans may not be your top priority — especially with mortgage or rent payments, utility bills, auto loans and living expenses demanding your attention.

However, failing to repay your student loans can hurt your finances. If you’re having trouble making payments, you may want to consider another approach, such as negotiating a student loan payoff with your lender and trying to settle for less than you owe.

You might want to consider a student loan settlement if:

Your loans are in default (or near it).

You have a lump-sum payment to settle your outstanding debt.

Your loans have been sent to collections.

Your credit is already damaged.

The alternative is a court judgment.

What is a student loan settlement?

Student loan settlement is when you settle your student loans for less than the amount you currently owe. If your loans are in default and you have a chunk of cash saved, your lender might be willing to negotiate a settlement agreement with you. It works best if you’re behind on your debt but can pay off a good portion immediately.

The amount of money you can save will vary by lender, and not all student loan lenders are willing to entertain settlement offers. But some might accept a settlement if it’s the only way they expect you to pay off your outstanding debt.

How to settle your student loans

Can you negotiate a student loan payoff? Absolutely. But before you begin negotiating, your loans will probably need to be either in default or near default. Some lenders may suggest an alternative repayment plan, but if your loans are far beyond hardship assistance, you can start trying to negotiate a student loan settlement.

1. Gather needed documentation

When seeking a student loan settlement, you’ll need to present evidence that your financial situation prevents you from paying the amount owed. Gather any documentation that might serve to show the hardship you are experiencing.

This documentation might include:

Paystubs

Tax returns

Proof of recurring expenses

Medical bills

Childcare expenses

Rent or mortgage payments

Any bill that currently accounts for large portions of your discretionary income can serve as evidence to prove your current situation is untenable.

2. Know your options

Your private student loan settlement options depend on your lender. Some lenders might require you to pay at least 90 percent of your loan, while others might be more lenient and accept less. The longer you go without making a payment, the less you might need to pay when you request a student loan settlement.

If you have federal loans, there are a few standard compromise options. You can pay:

The remaining principal and interest without any collection charges

The principal and half of the unpaid interest that has accrued since the loan went into default

90 percent of the current balance of principal and interest

There is also the potential for a discretionary compromise. This requires you to make an offer to the borrower for an amount you feel that you can reasonably pay back. You may offer a lower compromise amount than standard compromises, but the Department of Education must approve it to move forward.

How much money settling your student loans can save you depends on several factors, such as:

How much you owe

Outstanding collection charges and late fees

How far behind you are on payments

Sometimes, a settlement waives the late fees, collection costs or a portion of your interest. In some instances, you could get a small percentage of your principal balance waived as well. Depending on the circumstances, you might save 10 percent to 50 percent of your loan balance.

3. Let the lender make the initial offer

This move allows you to review and accept the offer or make a counteroffer. It’s your starting point for negotiating student loan payoff. Knowing your options beforehand allows you to negotiate a plan you’re comfortable with.

Be open if your loan servicer requests a different settlement offer, and don’t be discouraged if you end up going with a backup plan.

If you’re unsure how to get here, explain your situation to your lender and ask, “How can we go about getting this right?” or “What are my options at this point?”

4. Request a paid-in-full statement

Since this is outside of your normal payment plan, you’ll need to handle a settlement carefully. Get an offer in writing and have a lawyer review the terms with you. Once you’ve paid your debt in full, request a “paid-in-full” statement as part of your terms. Otherwise, you may still be on the hook for some of your outstanding loan balance.

Keep your paid-in-full statement handy in case lenders or debt collectors try to request money from you later on. You might also need it to request an update on your credit report or when you file your taxes.

If you receive a 1099-C from the lender after you settle your debt, you might have to pay taxes on the amount of debt the lender canceled. Canceled debt is often considered income.

When can I settle my student loans?

You typically can’t settle if your student loans are in good standing and you make timely payments every month. Even if you’re a little late on your last payment, you’re usually not eligible until default.

However, it’s not a good idea to intentionally default to settle. Lenders typically won’t agree to settle until they’ve exhausted all their debt collection tools.

You might qualify for federal student loan debt settlement if:

You can’t afford the loan: You must prove that you can’t repay your loan through pay stubs, bills or recent tax returns.

You haven’t paid your loans in almost a year: Most federal student loan servicers consider your loans in default after you’ve failed to make payments for 270 days.

You’ve re-defaulted: If you’ve defaulted on the same loan more than once, options like rehabilitation, income-driven repayment plans, deferment or forbearance may no longer be available to you. Instead, a settlement might be one of your last options.

Most private student loans default after 120 days of nonpayment, though this varies by lender. Your lender might accept a settlement offer if you can prove you don’t have income or assets to repay your loan. However, you’ll still need to come up with an offer worth accepting, which usually includes a lump-sum offer or a final amount paid over the course of a few installments.

Alternatives to student loan settlement

In many cases, student loan settlement should be a last resort, particularly since defaulting on your loans will damage your credit score, which could show on your credit report for years. You may have trouble borrowing down the line or face higher interest rates. You will also have to pay your settled amount as one lump sum, possibly while paying collection fees and interest.

Before settling your student loans, try getting back on track with your payments in other ways:

Deferment or forbearance: Deferment and forbearance offer a temporary pause on your student loan payments. Interest may continue to accrue, but it could still be worth it if taking a break from payments helps you get back on track.

Income-driven repayment plans: Available with federal student loans, income-driven repayment plans base your payments on 10 to 20 percent of your discretionary income (aka what’s left after taxes and covering your basic needs). If you don’t have a job, you could pay as little as $0 without facing any penalties, fees or harm to your credit. Plus, your remaining balance will be forgiven after 20 or 25 years of payments.

Refinancing: If you have private student loan payments you can’t afford, you might want to consider refinancing. If you have good credit, refinancing might help you secure a lower interest rate and perhaps a lower monthly payment if you choose a longer term. However, this last option will result in more interest paid over the life of the loan. It’s also worth noting that when it comes to federal student loans, refinancing may not be the best option since you’ll lose federal benefits by doing so.