Student Loan Debt Settlements
This page discusses debt settlement for defaulted federal student loans. The US Department of Education has very strong powers to compel payment of defaulted student loans, including garnishment of wages and Social Security benefits, income tax refund offset and blocking renewal of professional licenses. Federal student loans cannot generally be discharged in bankruptcy unless the borrower can demonstrate undue hardship in an adversary proceeding. The availability of income-based repayment, which reduces the loan payments to an affordable level, makes bankruptcy discharge of federal student loans very rare. But the US Department of Education does occasionally settle debt for less than what is owed.
Consider Income-Based Repayment First
If all you want is an affordable repayment plan, ask about income-based repayment. This bases the monthly payment on a percentage of your discretionary income, which is the amount by which your adjusted gross income exceeds 150% of the poverty line. This is an affordable amount for most borrowers, since it is based on your income, not the amount you owe, and often is less than 10% of gross income. If your income is less than 150% of the poverty line, your monthly payment is zero under income-based repayment. To obtain income-based repayment, you may need to rehabilitate your loans first. This may mean paying a higher monthly payment for 9 months before being able to switch to income-based repayment.
The monthly payment under income-based repayment is lower than the monthly payment under administrative wage garnishment for low and moderate-income borrowers and for borrowers with larger families. The monthly payment under income-based repayment is 15% of discretionary income (10% of discretionary income for new borrowers on or after July 1, 2014). The monthly wage garnishment amount is up to 15% of disposable pay, which is the amount that is left after deducting any amounts required by law to be deducted, such as federal income tax withholdings. Wage garnishment amounts may be lower, as the borrower must be left with weekly earnings after garnishment that are at least 30 times the Federal minimum wage ($7.25 an hour since July 24, 2009). (Social Security benefits may be garnished up to 15%, but the garnishment is typically reduced if the remaining benefit payment is less than $750.) But even so the income-based repayment amount will usually be lower than the wage garnishment amount.
Before Seeking a Settlement
When examining collection charges, keep in mind that the collection charges of 25% of the amount paid to principal and interest represent 20% of the total payment. (P = C + p + i, where P is the payment, C is the collection charges, p is the principal payment and i is the interest payment. Since collection charges are expressed as a percentage of principal and interest payments, C = 25% * (p + i). That implies that P = 5 * C, from which C = 1/5 of P or 20% of the payment.) Occasionally collection agencies get this calculation wrong and have collection charges that are 25% of the total payment instead of 20% of the total payment (or equivalently, 25% of the payments to principal and interest). This can lead to an outstanding loan balance that is as much as 12% too high if the error has been in effect for several years.
Nature of the Settlement
A settlement is a settlement, not a new payment plan. When seeking a settlement, offer a lump sum payment for satisfaction of the debt in full.
The US Department of Education will want to receive full payment of the settlement amount within a single fiscal year. The federal government's fiscal year runs from October 1 to September 30. In most cases the US Department of Education will want the settlement to be paid in full within 90 days of the date of the settlement offer.
In some cases the US Department of Education will allow a defaulted borrower to pay part of the settlement amount in monthly installments, but these installments will generally be paid within the same fiscal year.
Debts that cannot be Settled
The US Department of Education will never settle debts that involved fraud. It will also not settle any debts for which a judgment was obtained against the borrower except in the most unusual circumstances.
Amount of the Settlement
The US Department of Education will never settle for less than the default claim it paid for a FFELP loan or the principal balance on a Direct Loan. Settlements are almost always for much greater amounts.
The US Department of Education is also unlikely to settle debts at less than the current recovery rate. The recovery rate is the percentage of disbursements on defaulted loans that are recovered and includes interest and penalties in addition to the payments toward the principal balance.
The US Department of Education reports a 122.1% recovery rate on defaulted loans in the FFEL program and a 110.6% recovery rate on defaulted loans in the Direct Loan program, according to the Supplemental Materials from the President's FY2011 Budget. This does not mean that the government recovers more than is owed, as some defaulted borrowers assume, since interest continues to accrue even after the loan is in default. (To set the recovery rate in context, total payments on a 6.8% Stafford loan represent 138.1% of the original balance with a 10-year repayment term, 183.2% of the original balance with a 20-year term, and 234.7% of the original balance with a 30-year term.)
Thus the US Department of Education will usually seek a settlement that is at least 115% of the loan balance or the default claim paid at the time of the default. They may be willing to accept less if the default was very recent.
The US Department of Education will also consider how much they will be able to recover without a settlement by considering the cash flow they have been receiving from wage garnishment and offsets of income tax refunds. They will seek a settlement offer that is at least the net present value of all the future payments they expect to receive from the defaulted borrower. This suggests that a borrower would be best to argue for a settlement based on the impossibility of ever paying back the full amount even with wage garnishment and the withholding of income tax refunds.
A good starting point for a settlement negotiation is to offer to split the difference between the current amount owed and the amount of the original default claim.
The private collection agencies used by the US Department of Education have the authority to accept three types of standard settlements without prior US Department of Education approval:
The collection agencies also have the authority to offer a handful of non-standard compromises to borrowers each quarter. (The number of such nonstandard settlements per quarter is at most 6.) Such settlement offers are initiated by the collection agency, not the borrower, and do not need to be approved by the US Department of Education. However, the collection agency is required to compensate the US Department of Education for the difference from the net amount the US Department of Education would have recovered under one of the three standard settlements. In effect, the collection agency is forgoing all or part of its commission (or in some cases, taking a net loss). Such nonstandard compromises are used only in the most exceptional circumstances and are extremely rare. In almost all cases the collection agency will seek approval from the US Department of Education in order to preserve its commission.
Get the Settlement Offer in Writing
Before you agree to the settlement or make any payments, get the offer in writing. Make sure that the settlement indicates that it will satisfy all the debts in full. It's generally a good idea to have the settlement agreement reviewed by an attorney.
In some cases borrowers thought they were settling a loan in full, but were lied to by a collection agency who applied the payments to the debt without settling it. Or the borrower had both private and federal loans with the same lender and the lender settled just the private student loans, not the federal loans.
After you make all required payments as part of the settlement offer, you should receive a "paid in full" statement. If you do not receive such a statement, then the debt might not have been fully satisfied. The most common cause is a reversal of a prior payment, such as an injured spouse claim on an income tax refund offset. The borrower must make up the difference before the settlement will be effective.
It is important to have the settlement agreement in writing and a paid in full statement, since the unpaid portion of a settled debt can sometimes resurrect itself years later. For example, a lender may reconcile its records with the US Department of Education's National Student Loan Data System and "correct" the balance on your loan. If you have signed paperwork, it makes it much easier to prove that the debt was settled in full.
Who to Call
Start by calling the current holder of the loans. This may be the guarantee agency if your loans were in the FFEL program, or it may be the US Department of Education if your loans were in the Direct Loan program. You'll end up speaking to the servicer of the loans. Sometimes you'll get referred to the collection agency that has responsibility for collecting your defaulted loans.
When talking with the collection agency, keep in mind that they have a financial incentive to extract as large a settlement as possible, since they operate on commission. They may try for a larger settlement even though they have the authority to agree to a lower settlement. They may be focused more on collecting their commission than on reaching a reasonable settlement. You will need to be firm and repeat yourself multiple times. Also keep in mind that if you are asking for a non-standard settlement, they will have to get approval from the US Department of Education before agreeing to the lower settlement amount. Finally, remember that the collection agency has more experience than you in negotiating settlements.
The collection agency will not make or consider an offer to settle the account until after they have discussed your ability to repay the debt. The collection agency may ask for proof of your inability to pay the full amount owed, such as pay stubs (or a recent unemployment benefits letter), tax returns, W-2s, 1099s and bank account statements. You are not required to report an inheritance or other windfall that you have not yet received unless you are asked about pending inheritances. But if you have already received the money, it may affect the amount they offer as a settlement. If you are asked how you expect to pay for a lump sum settlement, the simplest answer is to say that you don't know yet.
If you are getting nowhere with the collection agency (e.g., they refuse to offer any settlement amount), try calling the US Department of Education's Default Resolution Group at 1-800-621-3115 or TTY 1-877-825-9923 or sending email to firstname.lastname@example.org. You can also try calling the FSA Ombudsman at 1-877-557-2575 or sending email to email@example.com. The FSA Ombudsman is not involved in negotiating settlement amounts, but sometimes they can help clarify a situation. If your loan is held by a guarantee agency, call 1-800-4-FED-AID (1-800-433-3243) for their contact information.
Note that the Fair Debt Collection Practices Act (FDCPA) does not apply to US Department of Education employees, but it does apply to the employees of the private collection agencies that are hired by the US Department of Education to collect defaulted loans. The FDCPA bans "abusive, deceptive and unfair debt collection practices" by debt collectors. US Department of Education rules bans private collection agencies from using harassment, intimidation or false and misleading representations to collect an account. If a borrower exercises their rights against a collection agency under the FDCPA, the US Department of Education will recall the account from the collection agency and either collect it itself or assign it to a different collection agency. The US Department of Education may also recall the account if a borrower makes a complaint against a collection agency but does not exercise their rights under the FDCPA.
How to Pay
Clearly, most defaulted borrowers are not in a position to negotiate a settlement because they lack the means to pay a settlement. However, sometimes defaulted borrowers can obtain a loan from friends and family (e.g., the borrower's parents might obtain a home equity loan to pay off the borrower's loans). This will save the borrower money if the settlement reduces the balance of the loan and/or waives the 25% collection charges. Other common possibilities include receipt of an inheritance, getting a bonus from one's employer or winning the lottery.
Offsets of federal income tax refunds can count as part of the settlement payment if they occur after the date of the settlement offer and before the 90-day deadline for paying the settlement amount. Offsets that post after the settlement is paid in full will be refunded to the borrower. (Generally it takes 3-4 weeks after an account is settled in full before the US Department of Education notifies the US Treasury to halt the offset of future federal income tax refunds.)
The US Department of Education requires that settlements be paid by a cashier's check, money order, certified personal check or credit card.
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