A frequently asked question from many borrowers is whether they can settle their student loan debt by means of a reduced, lump sum payment? Usually, the borrower is behind on payments, and a parent is willing to step up to the plate. That question leads to my first question, are we talking about a federal loan or a private/state loan?
Let’s assume that the loans are federal loans? The answer is that you can settle on a federal loan. The issue is whether it makes sense.
First of all, you can only settle on a federal loan if it is in default. That means generally that you are behind 270 days on payments. In other words, you missed 9 payments. Note that a default triggers a slew of collections efforts that do not require a court judgment.
The two main types of federal student loans are Direct Loans and FFEL (Federal Family Education Loans) What deals are the feds willing to make on a Direct loan? Well, there are general rules which indicate that the government will offer a compromise on a case by case basis based on all the facts and circumstances. However, the following options were spelled out in the DOE’s 2009 PCA manual (http://www.studentloanborrowerassistance.org/wp-content/uploads/2013/05/2009-pca-procedures.pdf):
100% of principal and interest with no collection fees;
100% of principal and 50% of interest with no collection fees; or
90% if principal and interest with no collection fees.
Note that you cannot demand by right the above options. The DOE has to agree to such options based on the facts and circumstances of your case.
The other principal type of federal loan is the FFEL which are issued by a private lender but guaranteed first by a guarantee agency and then ultimately by DOE. Guaranty agencies may compromise or settle for no less than 70% of principal and interest with no collection fees. The guaranty agency can theoretically give you a better deal, but it does not bind the DOE. So, if you make a deal for 50% of principal and interest with the guaranty agency, the DOE can come after you for the difference. It is important to get any compromise in writing and the writing should state that the DOE is bound by the terms of the settlement, and the DOE should sign off on the agreement.
The amount of the discount for a lump sum payment is rather underwhelming. Why won’t the DOE and guaranty agencies make a better deal? The reasons are many but two main reasons are that federal loans give the borrower the option to pay according to his or her income. And, the collection powers of the federal government are so strong that they know they are going to get their money- one way or the other.
So, the answer to the question of whether you can settle on a federal loan is yes, but the real question is why would you want to?