Can You Settle Student Loan Debt?

Settling student loan debt can be a viable option depending on the type of loan, your creditor, and your financial situation. A student loan debt settlement allows you to pay off your debt for less than the current outstanding balance. However, it is less common for creditors to settle student loans compared to other types of unsecured debt, such as personal loans or credit cards.

The options for settling student loan debt depend on whether you are dealing with federal or private loans. Typically, your loan will need to be in default, which occurs when you are 270 days past due with most federal loans and around 90 days past due with private student loans. During this time, fees and interest can continue to accrue.

Settling Federal Student Loan Debt

Federal student loan settlements, known as compromises, are governed by federal law. Loan servicers and collection agencies must follow specific guidelines when offering compromises. For example, they may need to attempt other collection methods first, such as garnishing your tax refunds and paychecks. They may also be limited to offering compromises only if it appears you will never be able to repay the debt.

When conditions are met, collectors can offer standard and nonstandard federal student loan compromises. Standard compromises may waive fees and potential collection costs, but you will 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

Nonstandard compromises can be made for a smaller amount without prior authorization from the Department of Education, but collectors are limited in the number of these compromises they can offer each quarter.

Settling Private Student Loan Debt

Settling private student loans may be easier because collection agencies have more discretion to offer and accept settlements. However, they will still consider whether they would make more money by continuing collections or suing you for the unpaid debt.

Pros and Cons of Settling Student Loan Debt

Pros

• You don’t owe any more debt: Once the settlement is complete, your student loan will be closed, and you won’t have to worry about collectors or lawsuits.
• Get out of default status: Settling the account removes the default status, which is important if you want to qualify for new loans, such as a 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

• 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, leading to a large tax bill. However, the American Rescue Plan Act (ARPA) of 2021 may exempt canceled student loan debt from federal 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:

1. Contact the debt collector or loan servicer to see if it will offer a compromise or settlement.
2. Gather documents that verify a financial hardship, such as bank statements, tax returns, and pay stubs.
3. 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. 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.

Contact O1ne Mortgage for Your Mortgage Service Needs

At O1ne Mortgage, we understand the complexities of managing student loan debt and how it can impact your financial future. Whether you’re looking to settle your student loans, explore refinancing options, or need assistance with a mortgage, our team of experts is here to help. Call us today at 213-732-3074 for personalized mortgage services and let us guide you towards a brighter financial future.