Grads looking to sidestep their student loan payments through debt settlement have a tough road ahead.
Unlike personal loans and credit card debt, federal and private student loans can't be dismissed in bankruptcy except in rare cases of permanent disability and undue hardship, says the Department of Education. While education loans are harder to shake than other kinds of debt, there could be recourse for those who get financially snowed under by student loans. Here are the facts on settling student loan debt.
You'll have to pay the principalStudents who dream of taking on massive loans and then settling them for pennies on the dollar are living in a fantasy world, says Greg Meyer, community relations manager for Meriwest Credit Union in San Jose, Calif.
"(Lenders) aren't going to settle for less than the principal balance on a loan," says Meyer. "Students may be able to get some of the collection fees and back interest waived if the loan is in default and if the lender knows that you'll never be able to pay it back."
FinAid.org publisher Mark Kantrowitz says that on federal loans, the Department of Education won't settle for less than the principal borrowed because the government already offers an income-based repayment plan designed to reduce student loan payments to an affordable level. Capping loan payments for Stafford, Grad PLUS and federal consolidation loans at 15 percent of a borrower's discretionary income, the income-based repayment plan introduced in July 2009 requires borrowers to fork over 15 percent of anything they earn above $16,000 and cancels all remaining debt after 25 years of consecutive payments. Borrowers who earn less than $16,000 won't have to make any payments at all and will still have their debt canceled in 25 years.
"Since the income-based repayment plan can essentially eliminate your loan payments if you don't earn enough, the Department of Education is extremely unlikely to dismiss your principal debt," says Kantrowitz. "With private loans, it's up to the lender."
Students can rehabilitate loans already in default by making 10 consecutive on-time payments; then they can switch to income-based repayment, says the Department of Education.
"When it comes to settling private student loans, you're basically on your own," says Anya Kamenetz, author of "Generation Debt: Why Now Is a Terrible Time To Be Young."
"Private lenders don't offer income-based repayment. You can offer them a repayment plan or settlement offer and hope that they take it, but that's it," says Kamenetz.
Don't overpayStudents who have interest and collection fees that have spiraled out of control may have no choice but to offer their lender a settlement. Before making an offer, Kantrowitz advises students to check their lenders' math.
"Students should review their payment history because it's not unusual for there to be mistakes," says Kantrowitz. "I've found errors (that affect) anywhere from 5 percent to 20 percent of the outstanding debt." The lender has to make good on all the interest that stems from a mistake, he says.