November 7, 2013
Why it's so hard to settle student loan debt
Settling student loan debt isn't easy, but it can be possible — if you're in exactly the right circumstances.
Troubled borrowers who can offer a substantial lump sum may be able to free themselves from years of wage garnishments, tax refund seizures and other collections efforts, according to student loan experts.
The key word is "substantial." Unlike credit card debts, student loan debts - which average $27,000 per student - can't be settled for pennies on the dollar.
"You'll never get that," said attorney Adam Minsky of Boston, who has brokered settlement deals for several clients. "But you can settle for anywhere between 30 percent and 80 percent...usually somewhere in the middle (of that range)."
Increasing numbers of borrowers are struggling with their student loan payments, according to the most recent Department of Education figures. About 600,000 of the 4 million borrowers who were scheduled to start payments in September 2010 defaulted, which means they failed to make any payments for 270 days or more. That three-year default rate of 14.7 percent was up from the 2009 default rate of 13.4 percent.
The Department of Education hasn't released figures about how many troubled borrowers have sought or been granted settlements. Student loan expert Mark Kantrowitz expects the numbers aren't high.
"About 10 percent of borrowers who sought my help obtaining a settlement ultimately were able to get a settlement," said Kantrowitz, senior vice president and publisher of college planning resource Edvisors.com. "Keep in mind that I hear from borrowers in extreme cases."
Even those who can scrounge up a lump sum — by borrowing from a family member, for example, or through a windfall such as a lawsuit settlement or an inheritance — aren't guaranteed success. That's because student loan collectors, in general, and federal student loan collectors, in particular, have so many ways to wring payments out of borrowers.
Federal student loan collectors can garnish wages, grab federal tax refunds and take a portion of government benefits, including Social Security, all without taking a borrower to court.
Indeed, the U.S. Department of Education recovers $1.11 to $1.22 for every dollar it's owed, figures that include collection charges and accrued interest, Kantrowitz said.
"They have incredibly strong powers to compel repayment," Kantrowitz said. A successful offer is "really the settlement that will provide more money to the federal government than they're already getting."
Federal student loan collectors will do a net present value analysis to figure out what lump sum today would generate the same future stream of payments expected from the borrower. An offer greater than that sum is typically required for a settlement to proceed, Kantrowitz said.
Borrowers whose wages aren't easily garnished, such as the self-employed or the frequently unemployed, may have an advantage since federal collectors won't expect much of a future income stream from them.
In general terms, federal student loan settlements usually take one of three forms, Kantrowitz said. The Department of Education may agree to waive collection charges, which can be substantial; it may knock 10 percent off the total owed; or it may settle for the current principal owed plus half the accrued interest.
In practical terms, borrowers who want a settlement should find out how much the Department of Education paid to acquire their defaulted student loans, and open negotiations with an offer halfway between that number and the total amount they now owe, Kantrowitz said. The amount the DOE paid, known as the default claim, is usually the last amount showed owing on the loans in the National Student Loan Data System database, he said.
MURKY SETTLEMENT PROCESS
The process for settling private student loans is less defined since lenders have different policies, Minsky said. Private lenders also have fewer powers to collect than the federal government, which sometimes — but not always — leads to more willingness to settle, he said.
Private lenders have to go to court to get wage garnishments and can't seize tax refunds or government benefits. Private student loans also are subject to state statutes of limitation that limit how long lenders can sue borrowers over unpaid debt. There are no statutes of limitation on federal student loans.
Borrowers, however, can unknowingly extend the statutes and invite lawsuits by making a single payment on an old debt or even acknowledging a debt is theirs, which is why Kantrowitz recommends hiring a lawyer to pursue a private student loan settlement.
Settlement certainly isn't an easy way out. Borrowers often face a tax bill for any portion of a loan that's forgiven, since tax authorities consider forgiven debt to be income. Settlements also have severe negative repercussions for borrowers' credit scores.
That's why Minsky counsels his clients to consider all other options first, including loan forgiveness, income-sensitive repayment plans and loan rehabilitation, a federal student loan program that expunges defaults from borrowers' credit reports after they make nine on-time monthly payments. Some clients decide to take those other paths, while others see a settlement as a way to close out a difficult chapter of their lives.
"Some people psychologically want to be done with it," Minsky said. "They say, 'I don't want to deal with this anymore. I want this gone.'"
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