Can You Settle Student Loans in Good Standing?

Settling student loan debt can provide relief if you’re struggling with high monthly payments or default But is it possible to negotiate a settlement if your loans are still in good standing? Let’s take a closer look at how student loan settlements work and when they make sense,

What Is Student Loan Settlement?

Student loan settlement involves negotiating with your lender or servicer to pay a lump sum that is less than the total amount you owe. If they agree, the remaining balance is forgiven.

For example, if you owe $50,000 in student loans, you could potentially settle this debt for $30,000. You pay the agreed amount as a one-time lump sum, and the lender considers the loans paid in full.

Settlement permanently resolves your debt obligation The loans are marked as settled on your credit report,

When Can Student Loans Be Settled?

The first thing to understand is that federal and private student loans have different settlement rules.

Settling Federal Student Loans

With federal student loans, settlement is only possible if the loans are in default status.

Default occurs when you are 270 days or more past due on payments. At that point, the loan can be sent to collections, and you become eligible for settlement negotiations.

However, if your federal loans are in good standing – meaning you’re making on-time payments – settlement is generally not an option. The Department of Education has no incentive to settle debt that is being repaid on schedule.

Some key facts about federal loan settlement:

• Only possible after defaulting
• Rarely approved unless you have a serious hardship
• Must pay at least 90% of total owed in most cases

Unless you’re facing extenuating circumstances like permanent disability, federal settlement will provide little benefit. You’ll still have to repay nearly the full balance.

Settling Private Student Loans

For private student loans, the timeline is different. You may be able to settle these loans before they ever reach default status.

Each private lender has its own policies, but many will negotiate with borrowers who are having trouble making payments. Some key points:

• Settlement may be possible before defaulting
• More flexibility than federal loans
• Could potentially settle for 50-70% of balance

If you have private student loans and are struggling to afford the monthly payments, it’s worth contacting your lender to ask about settlement options. Acting preemptively will put you in a much better position.

How to Negotiate a Student Loan Settlement

If you decide to pursue settlement, either for federal or private loans, the process involves these steps:

1. Gather documentation – To make your case for settlement, collect documents that demonstrate financial hardship. This can include medical records, income statements, expenses, and credit reports.

2. Contact the lender/collections agency – For federal loans, contact the Department of Education. For private loans, contact your lender or any collections agency your account was assigned to. Explain that you want to discuss settling the debt.

3. Negotiate terms – Be prepared to negotiate. Explain how much you can afford as a lump sum payment given your current financial situation. For federal loans, settlements are capped at 90% of the total owed in most cases.

4. Get the agreement in writing – If you come to agreed terms, make sure to get the settlement offer in writing before sending any money. Review the letter carefully.

5. Make the payment – Send your lump sum payment by the due date outlined in the agreement. Keep records showing the payment was made on time.

Settlement can provide relief, but it also damages your credit and requires coming up with a large sum of money upfront. Weigh the pros and cons carefully before choosing this route.

Drawbacks of Student Loan Settlements

While settling debt seems appealing, there are a few potential cons:

• Credit damage – Settled accounts appear on your credit report and can significantly lower your score. The impact can last for years.

• Tax consequences – The amount of debt forgiven may count as taxable income. Consult a tax professional to understand possible tax obligations.

• Collections – For federal loans, your wages or tax refunds could still be seized even during settlement negotiations. Collections activity may continue.

• Need lump sum payment – You’ll need access to a large sum of cash to make the settlement payment by the deadline. This can be very difficult.

For these reasons, settlement may be a last resort option if you have no other recourse. Don’t jump into it without carefully weighing the risks.

Alternatives to Settlement

Here are a few alternatives to consider before settling your student loans:

• Income-driven repayment plans – Federal direct loan borrowers may qualify for IDR plans with reduced payments based on income and family size.

• Deferment or forbearance – Get a temporary pause on federal loan payments by requesting deferment or forbearance if you’re facing financial hardship.

• Refinancing – You may be able to lower your private loan interest rate by refinancing with a private lender. This can reduce your monthly payments.

• Loan rehabilitation – Bring federal loans out of default by making nine on-time payments over 10 months under an approved rehabilitation plan.

Don’t rush into settlement without exploring whether these options could provide some breathing room. Settlement should be a last resort if your situation is truly dire.

The Bottom Line

Settling student loans in good standing is very unlikely with federal loans and hit-or-miss for private loans. Federal direct loans can only be settled in default, which damages your finances and credit. Private lenders may negotiate, but you’ll need to demonstrate real hardship.

Before considering settlement, make sure you’ve exhausted options like income-driven repayment plans, deferment, forbearance, or refinancing. Settlement can provide relief from burdensome debt, but it also comes with significant credit consequences and tax obligations to keep in mind.

The “7 year rule” for student loans refers to how long negative information, like late or missed payments and defaults, can remain on your credit report after a student loan enters default. Specifically, defaulted student loans and related collection accounts typically remain on your credit report for seven years from the date of the first missed payment that led to the default.