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You might be able to settle federal and private student loan debt, but it isn't always the best option. When negotiating federal student loan settlements, debt collectors have to take certain actions that don't necessarily benefit you. The federal government offers some reasonable alternatives for managing unaffordable student loans.
It's helpful to know about your loan settlement options, however, particularly if you have private loans or you don't think you'll ever be able to repay your student loans.
Can You Settle Student Loan Debt?
You might be able to settle student loan debt depending on the type of loan, your creditor and your situation. As with settling other types of debt, a student loan debt settlement allows you to pay off your debt for less than the current outstanding balance. When a debt is settled, the lender or collection agency cancels the remaining debt and closes the account.
Paying less than you currently owe might sound great, and it can sometimes be a good option. However, it may be much less common for creditors to settle a student loan than other types of unsecured debt, such as a personal loan or credit card.
The options and possibilities for settling student loan debt also depend on whether you're trying to settle a federal or private loan.
In either case, your loan will likely need to be in default, which happens when you're 270 days past due with most federal loans, and around 90 days past due with private student loans. Fees and interest can continue accruing during that time.
Settling Federal Student Loan Debt
Federal student loan settlements are called compromises. Federal law dictates when loan servicers and collection agencies can offer compromises and how much they can offer.
For example, a collector might have to make other attempts to collect the debt first, including taking money from your tax refunds and paychecks. They also might be limited to making compromises unless it appears that you aren't, and never will be, able to repay the debt.
When the conditions are met, collectors can offer standard and nonstandard federal student loan compromises. The standard compromises waive the fees and potential collection costs that you'd be responsible for, but you'll still need to pay:
- The unpaid principal balance and interest
- The unpaid principal balance and half of the interest
- 90% of the unpaid principal balance and interest
Debt collectors can make nonstandard compromises for a smaller amount without getting prior authorization from the Department of Education. However, they can only make three to six of these nonstandard compromises each quarter, and the collector is responsible for the extra forgiven amount.
Settling Private Student Loan Debt
Settling private student loans may be easier because the collection agency may have more discretion to offer and accept settlements. But the lender and collection agency will likely still consider whether they'd make more money trying to continue collections or suing you for the unpaid debt.
Pros and Cons of Settling Student Loan Debt
Settling your student loans might be a good option if you're struggling financially and don't see a path forward, especially because it's difficult to discharge student loans in bankruptcy. But there are pros and cons to consider.
Note: The Department of Education's temporary Fresh Start program affects many of the potential pros and cons through September 2024. Review the temporary changes it made to defaulted federal student loans if you're in default or are having trouble affording payments.
Pros of Settling Student Loan Debt
- You don't owe any more debt: Your student loan will be closed once the settlement is complete, and you won't have to worry about collectors or lawsuits any longer.
- Get out of default status: Your loan also won't be in default once you settle the account, which could be important if you want to qualify for a new student loan, government-backed mortgage or a U.S. Small Business Administration (SBA) loan.
- You might save money: A settlement will always be for less than the total outstanding balance.
Cons of Settling Student Loan Debt
- You might need a lot of cash: You may need to pay the entire compromise amount within 90 days, which could mean saving up and paying thousands of dollars.
- May increase your tax bill: The canceled portion of your loan could be considered taxable income, which can lead to a large tax bill. However, the American Rescue Plan Act (ARPA) of 2021 may exempt canceled student loan debt from federal income taxes (not necessarily state income taxes) through 2025.
- Might not offer much savings: Federal student loan standard compromises don't necessarily offer large savings. Even with private student loan settlements, the overall savings could be limited once you factor in all the interest and fees that accumulated.
- Can hurt your credit: Settling an account may be worse for your credit than repaying it in full. You'll also need to stop making loan payments and keep them in default for collectors to consider settling an account.
How to Settle Student Loan Debt
If you think settling your student loans might be a good idea, you can start the process by taking the following actions:
- Contact the debt collector or loan servicer to see if it will offer a compromise or settlement.
- Gather documents that verify a financial hardship, such as bank statements, tax returns and pay stubs.
- Consider discussing your situation with an attorney who specializes in student loans.
If your loan payments aren't past due yet, try to continue making your payments on time. You can also look into alternative payment plans and options, such as loan forbearance, that allow you to lower or pause your monthly payments without hurting your credit or getting charged extra fees.
Alternatives to Settling Student Loan Debt
Stopping your student loan payments in an attempt to get a settlement offer could end up hurting your credit and add interest and fees to your total balance. In the end, there's no guarantee that the collector will settle the unpaid debt.
Even if your loans are in default, settlement might not be the only—or best—option. Consider these three alternatives instead.
Federal Student Loan Rehabilitation
The Fresh Start program has temporarily replaced the standard federal student loan rehabilitation process through September 2024. The program can help you get defaulted student loans out of default, put you on an affordable repayment plan and remove the default from your credit history.
The Department of Education says about 80% of borrowers who enroll in Fresh Start choose an income-driven repayment plan, and most pay less than $50 a month—half pay $0 a month.
You can usually only rehabilitate federal student loans once, but the Fresh Start program won't count toward that limit. Additionally, there are several other student loan forgiveness options. And your monthly payments, even the $0 payments, may count toward those forgiveness programs.
Federal Student Loan Consolidation
Student loan consolidation allows you to combine federal student loans into a new direct consolidation loan. You'll need to either make three consecutive full payments or agree to repay the new loan with an income-driven plan to qualify.
Unlike with the Fresh Start program, unpaid interest and collection costs will be capitalized (added to your loan's principal balance) when you consolidate the loan. The record of the loan default also won't be immediately removed from your credit history.
Private Student Loan Refinancing
Private student loans aren't eligible for the federal programs, but you may be able to work out a hardship plan directly with your lender. Alternatively, you might be able to get a new loan and use the proceeds to pay off the existing student loan. Refinancing might be a good idea if the new loan can help you save money or lower your monthly payments.
Keep an Eye on Your Credit While Managing Your Student Loans
Temporary changes are affecting how student loans get reported to the credit bureaus. During what's being called an "on-ramp" period through September 30, 2024, there will be a pause on reporting delinquent payments on eligible federal student loans. Delinquencies of 90 days or longer won't be added to your credit reports until at least December 2024 or January 2025. Eligible defaulted federal student loans that are part of the Fresh Start program will be reported as current instead of in collections.
These changes might help your credit scores, and you can check your credit report and FICO® Score☉ for free to find out. Monitoring your credit can also be important if you're considering refinancing your student loans. Or if you want to refinance other debts to free up room in your monthly budget for student loan payments.