How to Settle Your Student Loan Debt: A Step-by-Step Guide

If you can’t make your student loan payments, you will not likely have them discharged as part of a bankruptcy proceeding—unless you can show undue hardship. Another option for your unmanageable student loan debt might be a compromise or settlement. In order to secure a student debt settlement, you’ll have to negotiate with your lender or servicer, either on your own or with the help of a debt relief company. The exact requirements will vary depending on whether you’re trying to settle federal or private student debt.

What Is Student Loan Debt Settlement?

Student loan debt settlement is a process by which your lender agrees to accept more than you owe on your student loan to close your account. For those who can’t make student loan payments but don’t meet the necessary conditions for bankruptcy discharge, settlement might be an option. You can pay a smaller amount and potentially set up more manageable payments.

With private lenders, student loan debt settlement depends on your lender’s individual policies. For federal student loans, the United States Department of Education refers to the process as a compromise, and you normally need to be in default.

Assess Your Financial Situation

Before moving forward with the debt settlement process, evaluate your financial situation. In some cases, especially with federal student loans, you might be able to get on an income-driven plan with a more manageable monthly payment, including $0 per month.

If you’re already in default with your federal or private loans, reach out to your servicer or lender to find out what their requirements for settlement might be.

Review your income and expenses, and make sure to note extenuating circumstances, such as a major loss of income or hardship due to medical costs or disability.

Gather Documentation

Next, gather any documentation you have to support your case for debt settlement. Some of this documentation, if applicable, might include:

• Pay stubs
• Tax returns
• Debt statements
• Bank statements
• Medical bills
• Notice of employment change
• Medical records showing disability or some other circumstance
• Public records related to divorce, bankruptcy, or other situations that might bolster your case
• Rent or mortgage payments
• Expenses like child care and other recurring expenses you must pay

Explore Your Options for Student Loan Debt Settlement

Depending on the types of student loans you have, you might have different options for student loan debt settlement. Private lenders set their own rules, so you might need to contact them separately to find out what programs they offer. Some might accept a large lump sum, while others might require a new payment plan.

With federal student loans, you first have to consider whether using an income-driven repayment (IDR) plan might work as well as a settlement. In order to use an IDR plan, however, you need to make sure you’re out of default. If you haven’t made a payment in 270 days, your loans are considered in default.

Standard Compromise

To get out of default, you have some standard options with federal student loans:

• Pay 90% of what you currently owe (including remaining principal and interest)
• Pay the remaining principal and interest without collection charges
• Pay the remaining principal plus half the unpaid interest accrued during default

Discretionary Compromise

You can also submit your own compromise with a lower payment than the standard compromise. However, your proposal needs to be approved by the Department of Education. You can also reach out to the Office of the Ombudsman for Federal Student Aid to get more information and potentially get help figuring out what you might qualify for.

When submitting a compromise, you generally need to have a large sum of funds available, since these compromises usually involve a lump sum in place of an ongoing payment plan.

Negotiate Your Student Loan Debt Settlement

As you go through the process of negotiating your student loan debt settlement, it’s important to follow these steps:

• Let the servicer or lender know you’re experiencing hardship and can’t pay the loan. Be prepared with documentation of your financial situation and hardship.
• Consider letting the lender or servicer suggest the first settlement amount. You can choose to reject the offer and make a counteroffer that works better for you.
• Determine whether a lump sum payment or monthly payment agreement would work best for your situation.

Get a Settlement Agreement

Once you agree to a settlement, get it in writing. Basic information that should be specified in the settlement agreement includes:

• The final amount that you will pay
• Payment terms, such as interval payments vs. lump sum
• The final date that the outstanding debt should be repaid
• A clause that indicates that you will receive a paid-in-full statement when the agreed-upon amount is repaid

Fulfill the Settlement Agreement

Once you sign the settlement agreement, it’s important to fulfill the terms as agreed. If you miss your agreed-upon payments or don’t make the lump sum by the required date, you could be liable for the full amount again.

When you complete the terms of the settlement, insist on the paid-in-full statement, so you have it for your records and can use it in the event that someone else tries to collect on the debt.

Impact of Student Loan Settlement on Your Finances

If you go forward with a student loan settlement, you should understand the potential impact on your finances.

Impact of Student Loan Debt Settlement on Credit Scores

In general, by the time you reach the student loan debt settlement stage, chances are that you’ve missed payments and your credit score has already been severely impacted. A debt settlement can lower your score even further and can remain on your credit report for up to seven years.

Tax Implications of Settling Student Loan Debt

Depending on the lender, you might receive a Form 1099-C, which represents the cancellation of debt. If you receive this form, there’s a chance that the difference between what you owed and what you paid as part of the settlement will be considered taxable income.

The Bottom Line

If student loan debt is keeping you from reaching your goals, debt settlement may seem attractive. However, it can be difficult to get approved for a student loan debt settlement. Instead, it might make more sense to work with your server or lender to see if there are hardship options available. Especially with federal student loans, various IDR plans might help you avoid the need for settlement while still resulting in manageable payments.

Carefully consider your situation and run the numbers to see if settlement is truly the right path for you. Review other options that might work better for your circumstances, including discharge if you have highly extenuating circumstances.