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Student Loans Student Loan Repayment

Is Student Loan Debt Settlement Worth It?

Updated Apr 05, 2023   |   4-min read

Late in 2017, the Department of Education reported that the number of student loan borrowers failing to make on-time payments for a prolonged period after graduation was on the rise. Nearly 11.5 percent of borrowers defaulted within three years after leaving school, and more are slated to join the ranks as college costs continue to rise.

For many students struggling to repay their student loans on-time, the constant concern over collection agency calls and destroyed credit may lead them to consider student loan debt settlement as an option.

Student loan debt settlement is the process of negotiating your total student loan balance down with the lender. When student loan debt settlement is successful, the lender agrees to take a smaller amount as payment for loans, without the account moving into the hands of a collections agency or a court.

But is it worth it?​

Debt settlement may be an option with both federal and private student loans, although the Department of Education has pre-set options for borrowers who want to settle for a different amount. Those include paying current principal balances plus any accrued unpaid interest, paying total principal with half the interest balance, or paying 90 percent of the principal balance owed.

Costs for Student Loan Debt Settlement

Debt settlement for student loans is only available to borrowers who are already in default on their repayment. Unfortunately, the biggest cost for student loan debt settlement is the settlement amount itself. Lenders only settle with borrowers who have the cash available to make the full payment up-front, not those who want a different payment plan. Many student loan borrowers in default do not have this cash on hand.

In addition to the obvious cost of debt settlement, students may also be taxed on any unpaid interest that is forgiven in the process. This can lead to a significant bill when tax season rolls around. In some cases, a student loan debt settlement does not offer substantial savings because of these extra costs and lump sum payment requirements.

How Much Can You Save?

Student loan debt settlement savings vary greatly from borrower to borrower, based mostly on the lender. With the Department of Education, a student loan debt settlement cannot be accepted for less than the current recovery rate, based on the loan program reviewed. The recovery rate is the percentage of disbursements on defaulted loans that are recovered over time, including interest, penalties, and payments toward principal balances. With high recovery rates, borrowers may not recoup much in savings when going through a student loan debt settlement.

Private lenders may offer more savings given they each have their own set of guidelines for how much they are willing to reduce the balance for settlement purposes. The amount may be a percentage of principal and interest owed, such as 80 or 90 percent. These savings could be significant for borrowers who have a vast amount of student loan debt, but far smaller for those with minimal balances.

Non-Financial Costs of Settling Student Loan Debt

In addition to the monetary costs of a student loan debt settlement, borrowers may also experience non-financial consequences going through this strategy.

Student loan debt settlements are reported to the three major credit bureaus and can have a negative impact on a borrower’s credit score. A settlement indicates you are not a good candidate for future lenders, which will make it difficult to get access to affordable credit for major purchases or other financing needs down the line. However, borrower can request the lender report the settlement as a paid debt as opposed to a settlement. This would likely have a lesser consequence on your credit score.

It is also important to recognize that a debt settlement requires a substantial payment to pay off the final amount owed. When borrowers do not have this capital readily available, they may go to friends or family members for help. While this can be a viable option for getting out from under student loan debt, taking a loan from family members or friends is not always a healthy choice. If you can’t repay them as planned there is likely to be a hit to a valuable relationship.

Student loan borrowers should consider their options for hardship deferment or forbearance, as well as income-driven repayment plans for federal student loans before debt settlement. Settling student loan debt successfully is a rare feat, so it is necessary to understand alternatives that have a smaller impact on your overall financial life.