Can You Settle With a Federal Student Loan Collection Agency?

They can seize everything but your diploma

Large debts are hard to swallow when repayment time comes around. These debts are even harder when they're the result of defaulted federal student loans. If you're struggling to repay your student loan debt or have already defaulted and are fielding daily calls from debt collectors, you probably already know that student loan debt is nearly impossible to get rid of. Even bankruptcy, in most cases, won't wipe away your student loan debt. In some cases, however, a settlement is possible if you know what to ask for.

Federal Student Loan Settlement Rules and Limitations

If you ask the collection agency handling your student loan debt for a settlement, you're likely to hear something along the lines of "You can't settle student loan debt." This is both true and false. The federal government won't allow you to pay less than the principal balance you owe and call the debt paid. It will, however, allow you to reduce your debt by lowering interest charges or eliminating collection fees. When you consider that the standard collection fee for defaulted education loans is a whopping 25%, settlement starts to look like a very good option indeed.

Debt Collectors Don't Want You to Settle Your Student Loans

The problem you'll encounter when attempting to reduce your student loan balance is the collection agency itself. In most cases, debt collectors receive bonuses and/or commissions for the amount of debt they collect.  Thus, its really not in a collector's best interest to let you settle your student loan unless there is very little chance of the collector receiving payment any other way.

If a collector won't work with you, hang up and call back until you find one that can. The U.S. Department of Education gives collection agencies the right to approve three types of student loan debt settlement:

• Types 1:  90% of the principal and interest charges. 

This doesn't mean that you'll only have to pay 90% of your original loan balance. Remember, you can never settle a student loan for less than the loan's principal balance. The 90% figure is the principal plus the interest. For example, if your principal balance was $40,000 and your interest charges were $10,000 that leaves you with a total of $50,000 (not including your student loan's collection costs). You would need to pay at least $45,000 to settle the debt using this method.

• Type 2: Waiving collection charges

Once you default on your student loan, you don't only owe the principal and interest, you also owe collection charges. These charges can tack thousands of extra dollars onto your loan. If you're willing to pay the full principle and interest, however, you may be able to get these collection charges waived.

• Type 3: Reduce interest by half

This one is pretty self-explanatory. For this type of student loan settlement, you'd need to pay the loan's principle and collection costs, but only half of the loan's interest.

The collection agency may utilize any of these three settlement methods without prior approval from the U.S. Department of Education.

Settle Your Student Loan With a Lump Sum

As excited as the prospect of reducing your student loan debt may be, I might be about to burst your happy little bubble – you'll need to pay the settlement in a lump sum. Yeah, that one hurts, doesn't it? Here's the deal, the federal government has the right and the ability to squeeze the entire debt out of you over the course of your lifetime. They can garnish your wages, seize your bank accounts, seize and sell your personal property and garnish your tax refunds. There is no statute of limitations on a student loan debt, so these forcible collection activities can continue forever and ever amen.

Settling student loans may break the bank

If you're a big, powerful government entity and a debtor owes you $50,000, you're not going to cut him a $5000 break unless there's something in it for you. Since the debtor would be paying in payments anyway, it does not benefit the Department of Education in any way to accept payments for $45,000 when they could be getting payments for $50,000. You'll only make it worth their while to reduce your student loan debt if you give them a lump sum up front. They benefit by not having to wait for the money and you benefit by getting the loan settlement you need. The catch here is that if you had that kind of money just laying around, you wouldn't be trying to settle your student loans in the first place. Hence the reason settling defaulted student loans isn't an option for most people.

Asking for a Written Settlement Offer for Your Defaulted Student Loan

If the collection agency agrees to settle your student loans, restrain yourself. Running to the bank and getting a nice fat cashier's check or money order and sending it straight to the collection agency is a bad idea indeed. Before you pay, ask that the collection agency put your debt settlement offer in writing. Collection agencies responsible for recovering student loans don't magically become ethical organizations just because they have a government contract. Collection agencies that collect on defaulted student loans are just as likely to screw you over as those that collect other forms of debt.

Review your settlement offer carefully and make sure it clearly illustrates the terms of the settlement and the fact that any remaining balance will be forgiven. If the agreement does not absolve you of your responsibility for the balance, you shouldn't be surprised if another collector shows up a few months down the road demanding that you pay the $5000 or so that you saved when you settled your federal student loans. Remember, the phrase "written off" is NOT the same as "forgiven."

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