Settling student loan debt not a slam dunk

Students can obtain a copy of their payment history through their lender or, for federal loans, through the National Student Loan Data System. Borrowers should immediately bring any mistakes to their lender's attention and follow up to make sure the lender subtracts the appropriate interest and collection fees.

Calculate a compromise

If settlement is the only option, students should be prepared to prove that the interest and collection fees have grown so rapidly on the loan that it will be impossible to pay it back, says Phillip Cervin, vice president of collections for the Texas Guaranteed Student Loan Corp., or TGSLC, a Round Rock, Texas-based nonprofit that administers federal Stafford and PLUS loans.

"Borrowers are in a better position to settle if they can offer us a lump sum," says Cervin. "When a borrower comes to us and says 'I have an $8,000 loan and I owe $10,000 on it but I can pay you $8,000 right now,' that's when we would evaluate that borrower's case to see if their financial situation warrants reducing the debt."

The obvious Catch-22 is that indebted borrowers with loans in default typically don't have piles of cash sitting around. Cervin says that most borrowers who settle their debts with TGSLC do so because they receive an unexpected fiscal bonus such as an inheritance or a significant raise. Students who don't win the lottery or find thousands hidden in their couch cushions may be able to settle their debt by asking their parents to take out a home equity loan. Once the student loan has been settled, borrowers can focus on paying their parents back at a reasonable interest rate rather than fighting off skyrocketing collection fees.

"Once you've got (a lump sum), the best time to work with us is within the first 60 days that the loan has gone into collection," says Cervin. That way, it won't get reported to the national credit bureaus, he says.

Mind the taxes

Once a settlement figure is set, Meyer advises students to ask the lender if settling their loan has any tax implications.

"The student may get a form from the lender saying, 'Since we forgave $11,000 in debt, you're being taxed on that $11,000,'" he says. "If a student is in the 30 percent tax bracket, on $11,000 they're going to be paying out about $3,300."

Meyer also advises borrowers to get their settlement in writing and make sure that it clearly states that 100 percent of the debt is paid.

"Getting (the debt settlement) in writing is absolutely crucial because if you don't, you just don't know what kinds of bills you're going to get hit with," says Meyer.

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