Student Loan Settlement: Rescue your Defaulting Loan

Learn about student loan settlements. Includes details on when you can and can not get a settlement, ways to get one and how settlements work. Find out the reasons for federal and private settlements, how much you can save, consequences and alternatives to a student loan settlement.

Updated by B Harshitha on 17th July 2020

Millions of students in the US go into default every year due to their inability to pay back their student loans causing them to end up in a situation worse than where they began. Allowing your loans to go unpaid for a long time can have adverse effects. Your taxed could get offset, your wages could be garnished and you could be the target of a number of legal actions. Learn more about the terms and technicalities related to student loans to learn how your specific loan works and to avoid any ambiguities.

Student loan forgiveness is one means by which defaulting borrowers could get some relief and even end up paying less loan than what they initially borrowed. This relief mechanism is different from forgiveness and discharge in a number of ways: forgiveness cancels your loan in exchange for an agreement from you to work in certain specific occupations under specific circumstances whereas discharge cancels the remainder of your debt in cases of death or disability or bankruptcy. 

Borrowers can think of deferment or forbearance for short-term difficulties to repay their loans. Your interest will continue to accrue and you are only temporarily relieved from your obligation to repay your loans. For a long-term financial difficulty, borrowers might think of changing their repayment plan to income-based repayment or extended repayment. These plans increase the term of repayment but help in reducing monthly payments, but may also increase the total amount paid over the course of time. Learn more about the different student loan repayment plans available to find one that works best for you.

Settlement works quite differently.


What is Student Loan Settlement?

You may be able to pay less than what you owe to your lender if you apply for a settlement on your student loan. A loan settlement is an agreement between your lender and yourself where, seeing your inability to make continuous payments, the lender accepts less than what is owed by you in one full payment. Borrowers who can not afford to make one big payment will be given a modified plan.

For a student loan to be settled, it is usually a prerequisite that it is in default. Lenders usually will agree to settlements if they have reason to believe that you are incapable of making continued payments on a regular basis.

Most federal loans, consider your loan to be delinquent for about the first 9 months that you have missed payments for. Perkins loan considers your loan to be default after the first payment itself.

When can you settle your student loans?

Your loans will have to be in or near default for federal and private lenders to consider your student loan for settlement. Most private lenders star defaulting your loan after 120 days of missed payments, while federal loans enter into default after 270 days of past-due payments.

If your loan is not in default or if you have the ability to pay down your debt, you will not be eligible for settlement. The best time to apply for settlement would be when your loan is defaulting but no legal action has been made yet.

A student loan settlement is quite different from forgiveness or discharge, where your loan balance is waived off under certain circumstances. In a settlement, your lender is agreeing to “settle” for a lesser amount than what was originally borrowed by you. This will help you resolve your debt without any collections or judgments or court actions. 

Federal student loan settlements offer these three standard payment options:

  • You may pay your current principal balance, all accrued unpaid interest, and all your future collection surcharges and fees will be waived off

  • You may pay the total principal and half of your interest balance where the other 50% is forgiven

  • You may pay 90% of the total principal and balance that you owe, i.e 10% discounted

With any of the above plans, you will be expected to make one single lump sum payment within 90 days of your settlement agreement.

In some cases, you may be allowed to make your settlement repayments on a monthly basis within one fiscal year.

When can you not apply for a settlement on your student loan?

In some cases, student loan debt can’t be settled. Specifically, if any of the following apply to you, you could be ineligible.

  • You’ve purposely defaulted on your student loans just to avail settlement: “Strategic default” is considered to be a form of fraud and can lead you to bigger trouble. If you become delinquent with the idea of going into default, you may lose the opportunity to settle and you will still owe your full balance as interest continues to grow.

  • A court judgment is issued against you: After lawsuits are filed and judgments are made, you will be ordered by the court to pay your lender what you owe them. It will be too late at that point to request for a settlement.

  • You’ve come into a large sum of money: Lenders won’t agree for a settlement if you have sufficient cash to repay your loans or debt balance in full. This is because a settlement is mainly approved when someone is under a lot of hardship.

Ways to get a Student Loan Settlement

Settling student loans can be done either on your own or with the assistance of an experienced negotiator:

  • Contact the company that is in charge of handling your defaulting student loan. This could be a collection agency. Ask them about the settlement options that you can avail.

  • Choose an attorney who is adept at handling student loans or settlements. It would be good to remember that you are not often guaranteed more savings than on your own with an attorney and you may incur legal fees. Attorneys are most useful if you have been sued by your private student loan lender.

  • Fund an account with a debt settlement company if you are still making payments. You will be stopped from making said payments. This settlement company will negotiate a settlement once you have kept sufficient money. It is advisable not to take this route if your loan is not in default. Most lenders do not agree to negotiate with settlement companies.

  • Always remember to get an agreement to settlement in writing. After paying your settlement amount in one shot, make it a point to receive a receipt and keep it carefully in case any references to it rise in the future.

How Do Student Loan Settlements Work?

Settlement options can be availed for both federal and private student loans, but usually student loan settlement follows a three-step approach:

1. Talk to your lender about student loan settlement: If you haven’t repaid your student loan in a while, the lender has all the rights to take some necessary steps to collect his money from you. He may choose to delegate the collection work to a collection agency. He is also well within his rights to withhold your tax and social security benefits or garnish your wages up to as much as 15% or even take your driver’s license. He doesn’t have to go through court to do any of the mentioned. Your loan amount may increase if the lender chooses to handle things with the involvement of  a collection agency. Collection fees incurred by the lender will be added to what you owe them. Collection agencies are authorized to carry forward with three standard settlement options. For any custom plans, they will need approval from the U.S. Department of Education. They may approve:

  • You may pay your current principal balance, all accrued unpaid interest, and all your future collection surcharges and fees will be waived off

  • You may pay the total principal and half of your interest balance where the other 50% is forgiven

  • You may pay 90% of the total principal and balance that you owe, i.e 10% discounted

If your student loan goes unpaid, you and cosigner may be contacted first via calls and letters. The lender is also permitted to take legal action against you, although he can only sue you after a number of years. But if they succeed in suing you, they can have your wages garnished or get a hold of your home. It is often noted that it is possible to get better settlements on your student loans with private loans than with federal loans.

2. Negotiate the settlement: Having a session of negotiation with your lender before your repayment plan commences/before you plan to start a settlement is important. This is because collection agencies are expected to make large payments from delinquent borrowers. You may hire an attorney, get in touch with a debt settlement company or start a settlement on your own. Before deciding on settling your student loan with an attorney or a debt settlement agency, make sure to ask them to disclose all terms and conditions to you. The fee that you will have to pay an attorney or a settlement agency would usually be a percentage of how much money they save for you. There is a rule that states that loan settlement agencies can not charge you any money until the settlement is finalized. If you are planning on handling the settlement process yourself, then be careful with your personal and financial information. Do not unnecessarily divulge any extra information that may be sensitive and can be used against you to the student loan lender. Keep it in mind never to divulge details about your bank account balance. Instead, simply tell them what you can afford. Often in the end, going the extra mile and hiring an experienced professional handle your settlement becomes worth it in the end.

3. Pay the decided amount: Make a proper payment of the negotiated amount. Do not plan on indulging in any last-minute fraudulent activities. The settlement deal has to be received by you, the borrower in writing and after you pay, a receipt stating the status of your payment has to be received. Make copies of the same just in case. In the settlement offer provided to you in writing, ensure that all the terms, dates, amounts and deadlines are specified clearly and explicitly. Within 90 days from the date of the settlement agreement, you will be expected to make a lump-sum payment if you are dealing with the federal government. With private lenders, you have the flexibility to negotiate your terms. With your private student loan, in a settlement, you may either make a lump-sum payment or an installment payment.

Reasons for Federal Student Loan Settlements

It is not very common for federal student loans to get settled. Most federal student loan lenders along with the Department of Education have a number of methods up their sleeve using which they get a hold of their borrowers’ money that is owed. Wage and tax refund garnishment are some of the many ways by which they get money from defaulted student loans. An exception is made for one of the following reasons:

  • Borrower can not afford to repay the loan: No hardship standard has been necessarily set that has to be met by a borrower’s financial condition in order to qualify for a student loan settlement. Copies of tax returns, pay stubs or any financial documentation can be presented to prove your hardship. If you qualify for the repayment plans of Pay As You Earn or Income-Based Repayment, the Department of Education may consider you to be in financial hardship. This is because to qualify for these plans, according to the Department of Education’s calculations, you have to be in partial hardship.

  • Your student loan has defaulted more than once: Debt settlement can likely not remove a defaulting student loan from your credit history. Rehabilitation succeeds in achieving complete recovery from student loan default. But it so happens that a defaulting student loan can only be rehabilitated once.

  • Your loan holder can’t find any other means to collect your repayments: Student loan lender may agree for a debt settlement because they can not think of any other means to get your money. This may happen if you  move abroad and your wages or tax refunds can no longer be garnished or seized.

Reasons for Private Student Loan Settlements

Since private student loan lenders do not have the collection leverage of their federal counterparts, settlements for private student loans are more common. A private student loan lender may agree to a settlement due to the following reasons:

  • You have limited income or assets: A decision will be arrived at by your student loan lender depending on their perception of your ability to repay your loan. You have to present to them how they will not be able to get any considerable amount of money from you in the future.

  • You have good legal defense: By suing you, private student loan lenders may try to force you to repay your debt. If they win the court judgment, they could garnish your wages or collect money directly from your account. But you could prompt a settlement or even dismissal of your debt if you can prove in court that the statute of limitations on your loan has expired.

How much can a settlement on your student loan save for you?

Settlement amounts vary greatly between lenders when it comes to private student loans. Some will be reluctant to accept anything less than 80% of what is owed while others will even agree to as low as 50%.

Your savings may not be as considerable with federal student loans. You will be provided with a specific set of guidelines stating all the terms and conditions regarding settlement by the Department of Education. You may settle for one of the following:

  • 100% of your collection costs will be waived.

  • 50% of the interest that you owe will be waived.

  • 10% of your principal and interest will be waived.

Under the Federal Family Education Loan Program, if you have any loan, the organization that takes responsibility for these loans in default could additionally provide you with another option: they could waive 30% of your principal and interest.

Regardless of whether you have federal or private student loans, with settlement, the amount that you do not pay may be taxed. Enquire about the same with a tax specialist.

Consequences of settling your Student Loan

Here are some things that you need to know about the aftermath of availing a settlement on your student loan:

  • Your credit score will be affected: Post delinquency or settlement, regardless of whether your student loan was/is federal or private, your credit score will inevitably take a hit. Once delinquent, a federal student loan may be reported after 90 days of missed payments. Whereas, private student loans may be reported immediately when they are late. On average, borrowers may end up losing anywhere between 50 and 90 points on their credit score before they reach default on their student loans. If you took the loan with a cosigner, their credit scores will also be affected. A poor credit history can make it difficult for you to get a mortgage or a lease on an apartment or even pass an employment check. After the student loan is settled, this status will remain on your credit history for up to a period of 7 years.

  • You'll owe taxes: Any part of your debt that was cancelled or saved in the settlement will be included in your taxable income. Consult a tax adviser and enquire more. Exemption from this taxation is possible if you qualify for it. If you don’t, get an estimate of how much you'll have to pay. Be aware of the tradeoffs between your settlement savings and the tax that you will have to pay.

Alternatives to Student Loan Settlement

Settling your student loan is not the only way by which you can relieve yourself of concerns regarding your burgeoning loan that is likely already in default. It has been noted that about 70% of borrowers get out of default within 5 years, whereas 30% find themselves capable of paying off their debt entirely in that time.

Restoration of a loan that is in default is essential. While the Department of Education offers clear steps to borrowers to get out of default, for private student loans, there is no clear path. Your rehabilitation options will vary from lender to lender. With federal student loans, you may pay off your debt in a lump sum or opt to pay back in installments or even consolidate your loans.

The following are some alternatives to student loan settlement:

  • Income-driven repayment plans: You can choose to repay your student loan on a monthly basis where a part of your income will be taken as repayment. This is for as long as your loan is not in default. If your income is low enough, you may be eligible for  a zero dollar monthly payment.

  • Deferment or forbearance: This is primarily offered with federal student loans and can even be discussed with your private student loan lender. They enable you to temporarily reduce or even stop student loan payments. In a deferment, you may not have to pay the accumulated interest depending on your loan. But with forbearance, you may have to pay accrued interest.

  • Student loan forgiveness: Most federal student loans are eligible for student loan forgiveness programs. They are offered based on your profession, state or employer.

  • Private lender hardship options: Bring a clear detailing of your finances to nonprofit organizations such as the National Foundation for Credit Counseling. They may be able to help you figure out what you need to pay. They may even help you communicate your situation with your lender better. Then discuss about hardship programs with your private student loan lender. 

  • Refinancing: In general, refinancing federal student loans into new loans is not preferred because of all the federal benefits that you may miss out on. But with refinancing, you may be able to make your monthly private student loan repayment more affordable. If your credit score and history are good, you may even be able to qualify for low interest rates with refinancing. Refinancing usually helps borrowers handle their loans better as one single payment.

All of the above options are alternatives to student loan settlement that you can think about if you are concerned about damaging your credit score with settlement. Student loan refinancing is one of the most preferred and sought after methods to deal with student loans these days, mainly because of how it makes student loans more manageable and the repayment process more efficient.

In conclusion

Before making any settlement payment, ensure to get the settlement agreement in written form.

Review any settlement agreement's terms and conditions before entering it to ensure that it settles all the debts that you want to settle in the way that you would prefer. A “paid-in-full” statement has to be issued by the lender after you pay the complete settlement amount. Explore and learn more about all the alternative options to student loan settlement that are available to find one that is most favorable for your circumstances. And also remember that, although the settlement can give you a shot at permanent relief from student loans via a single lump-sum payment, it can also have lasting, dire effects on your credit score.

Student loan default affects your financial, professional, personal life drastically. Therefore it is advised to take measures to not enter default. Still, if you find yourself in default, Handling student loan default helps pay back your debt faster.Postpone student loan payment can also be a useful option to consider. 

If you have private student loans, the number of repayment options are less. But missing on-time payments will land you in default loansPrivate student loan default describes the causes, consequences, prevention, and help needed with Private student loans. 

When loans (federal loans) are not paid for a certain period of time (90 days), your loans are in delinquency. Similarly, loans not paid for about 90 to 270 days, they become default student loans. Know the difference between default and delinquency


Finally, with all these support from ED and private lenders, gradually the number of default loans is declining as years pass by. Student loan default statistics concludes the default loan details and statistics.  It is necessary, to understand how important it is to avoid student loan default as it can affect you in multiple ways. 

Other details on rates, consequences, and settlement Student loan default and delinquency give drawbacks to it. Student loan rehabilitation is a displinary action taken to get out of default, which requires you to pay 9 month of repayment on time and the default status will be removed.

Refinancing your student loans helps you to manage your payments, and also lower your interest rates. Any steps taken in advance to manage your repayment will help you not enter default and delinquency. It is advised to have an in-depth understanding of how to Refinance defaulted student loans

Resources for Settlement of Student Loans

Find your servicer here: 

National Student Loan Data System (NSLDS):

Learn more about Student Loan Servicers.

The Federal Student Aid Information Center (FSAIC) can help by providing more information. 1-800-4-FED-AID (1-800-433-3243).

Here are some relevant contacts for students seeking a settlement on their student loans:

Default Resolution Group:


TDD/TTY 1-877-825-9923

[email protected]

FSA Ombudsman:


[email protected]