Can I Settle My Student Loan Debt?

Settling student loan debt is far more difficult than settling credit card debt or medical bills. This is because student loans are, in a vast majority of circumstances, not dischargeable in bankruptcy.  The only way to discharge your student loan debt in bankruptcy is to file an adversary proceeding in bankruptcy court and prove to the judge that paying back your loans would cause you and your family an “undue hardship.” Besides the fact that each judge interprets the law differently, it is next to impossible to prove this up. To put it in perspective, less than 1% of debtors have successfully wiped out their student loans in bankruptcy. But don’t lose hope yet, there are still a few options left to deal with unmanageable student loan debt.

Federal Student Loan Settlement

Settling federal student loan debt is very difficult because the government has very powerful collection methods that private student loan lenders do not. For example, the government can seize tax refunds, garnish a portion of social security income, garnish a portion of other government benefits (like social security disability), and even garnish your wages, all without suing you first. You see, a private student loan lender must first sue you in state court, prove their case before a judge, and secure a judgment against you prior to being able to garnish your wages. Not so for student loans from Uncle Sam.

As a result of being granted these ridiculously powerful collection methods, the federal government is only likely to settle a student loan debt for a large, lump sum payment. Because the government provides so many programs offering assistance to borrowers falling on hard times, such as the income based repayment plan and the income contingent repayment plan, they are not likely to accept a stream of payments as settlement. Any settlement will usually have to be made within 90 days and will conform to one of these scenarios:

  1.  Waiver of collection charges, but the full principal and unpaid, accrued interest must be paid in full. While this may not seem like a great deal, collection charges can be substantial on federal loans.
  2. 90% of the current principal and interest balance.
  3. Payment of the full principal balance and only half of the accrued interest.

As you can see, settling your federal student loans is probably not in the cards unless you happen upon a huge windfall, like an inheritance or a substantial loan from a family member. I would recommend a loan because any large gift from a family member will be subject to a gift tax.

Make sure any offer you receive to settle your federal debt is in writing. You may have read that the government is using third party collection agencies to pursue  borrowers in default, and these agencies don’t exactly have the cleanest track record. They certainly don’t have your best interests at heart.

Private Student Loan Settlement

Private student loans are just like any other private loan with the significant exception that they are not automatically discharged in bankruptcy.  Because private lenders do not have access to the incredibly powerful collection methods of the government, they may be a little more eager to settle.  Like any other lender, they must first file a law suit against you in state or federal court and prove that you owe the debt. If they can prove their case, they will secure a judgment against you for the amount of your loans, plus interest and attorneys’ fees. In short, they are subject to your state’s normal garnishment laws, just like every other creditor. They are also subject to your state’s statute of limitations for suing on a contract. In Georgia, that is six years from the date of default.

In my experience, private lenders will rarely settle for less than 40% of the outstanding principal and interest. Just as with federal student loans, most lenders will only settle for a one time, lump-sum payment. And lenders who do settle for such a low percentage payout are usually facing borrowers who are, in effect, judgment proof, such as elderly borrowers with no assets subsisting on social security.  Self-employed borrowers, whose wages are far more difficult to garnish, may also have an easier time negotiating a lump sum settlement amount.