Some federal student loans get written off entirely
Most people who go into default on a debt realize there is a limited time during which the creditor can take to enforce the claim. This statute of limitations prevents people from being hounded for past due debts for the rest of their lives. Unfortunately, there is no statute of limitations when it comes to federal student loans.
That’s not to say, however, that the government will chase you for your defaulted federal student loan for the rest of your life. In fact, the government has the ability to write off your educational debt and suspend collection efforts either temporarily or permanently. 31 CFR 903.1 says that “agencies may suspend or terminate collection” with respect to federal student loans with a balance of up to $100,000, though the U.S. Attorney General has the power to suspend collection on debts over $100,000.
The decision to write off the loan is made on a case-by-case basis, and often the result of the borrower’s financial prospects. Writing off the debt differs from a compromise but can be helpful for some people.
Don’t avoid paying student loans to improve settlement options
Some people read about settling federal student loans and embark upon a course of action known as strategic default, which involves going into default to get a creditor to settle. Though this may be useful for other types of debts, that’s not the case when it comes to federal student loans. In fact, strategically defaulting on your federal loans could reduce your chances of getting a compromise.
The debt collector can compromise your federal student loan only after the Department of Education verifies your inability to pay and its own inability to collect through other enforcement mechanisms. In determining your ability to pay, the government will look to your present and potential future income, inheritance prospects, and the availability of assets or income that could be used to satisfy the debt.
The government will also investigate whether you concealed or improperly transferred assets or money. If you’ve been putting aside cash in the hopes that you can use it to pay for a compromise, the collector is likely to consider those funds as available to pay the debt.
In the end, you’ll have a wrecked credit report, massive additional interest charges and collection fees, and an empty bank account.
Why I seldom recommend that clients settle federal student loans
Let’s go back to the original loan scenario and pretend you have a total outstanding balance of $94,706 in federal student debt. Assuming you can get your hands on the money, you might be able to settle the loan for $66,786.
That creates the following problems:
- You may have to pay taxes on $27,920 – the amount of the debt that was canceled.
- You lose the ability to invest $66,786, which limits your opportunity to generate a positive rate of return.
- If you have a financial emergency after you pay the compromise, you’re less likely to have the money to provide for yourself and your loved ones.
In other words, settling a federal student loan will often put you into a worse financial situation.
Rather than settling the federal student loan, you might be able to consolidate your way out of default or rehabilitate the loan back to good standing. Resolving the default will not only improve your credit score but will remove the possibility of enforced collections.
From there, you can look into one of the many Income-Driven Repayment (IDR) plans available for federal student loans. These IDR plans allow you to adjust your monthly payment based on taxable income and family size. If your income is low enough, you could end up paying as little as $0 per month and set yourself on a long-term path to student loan forgiveness. There are also a variety of forgiveness programs available based on income, disability, and other situations that may be a better financial choice.
Even if you don’t have a low income and enter into a standard repayment plan for your unpaid balance, the payment on $94,706 worth of student debt at 6.8% interest would be about $620 per month for 360 months. Spreading the payments over time allows you to remain in control over your money, letting it work for you even as you pay the loans off.
Should you hire a lawyer to settle your federal student loan?
If you’re thinking of settling your federal student loans, it’s a good idea to talk with a licensed professional who can see all the angles. Get a lawyer, a financial planner, an accountant – but make sure you’re dealing with someone who has a license and a real understanding of the situation.
Run all the numbers, consider whether you’re eligible to have your loans forgiven, and be sure to make the wisest financial choice. Don’t let your emotions determine your actions – it’s usually not something that leads to a good outcome.
Above all, move deliberately rather than quickly. There’s a lot of money on the line, and you can’t afford to make a costly mistake.