Possible drawbacks to student loan settlement

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Written By KennethChing

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Although it sounds great to settle student loans for less than you owe, there are significant disadvantages.

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Your credit will be affected

You must be in default to settle student loans. Federal loans will mean that you are 270 days behind on your payments. Private loans are typically at least 120 days behind. However, the exact time frame may vary from lender to lender. You can make other creditors suspicious if you miss too many payments. This will cause your credit score to be severely damaged.

The default will be removed from credit reports if the loan is paid off. The account will still show up as a paid debt. Settlements will show that you haven’t paid the entire amount and will remain on your credit report for seven year. A settlement on your credit history could make it more difficult to get other credit forms.

You may be required to pay taxes

You may owe taxes if you pay off your debt. The IRS considers the income portion of the waiverd amount income. If the amount you have been paid is greater than $600, your loan holder will send a 1099 form to you. You’ll need to report the information on your tax return, and pay taxes.

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The Lender cannot guarantee that they will agree to your request.

Although you may be able to make compelling arguments to your loan holder they are not likely to agree to your settlement proposal.

Mayotte says, “Keep in Mind that the borrower is legally bound to the promissory notes they signed. A lender is not under any obligation to accept a settlement. Instead, a lender can choose to litigate for collection.”

Alternatives to Student Loan Settlement

Settlement of student loans should not be your first choice. There are many ways to make student loans less stressful if you have trouble making your payments.

Leslie Tayne, founder of Tayne Law Group and student loan expert, says, “Before you go into default, try finding ways to repay and work together with your creditor.” Remember that defaulting on student loans can cause credit damage. If you do it correctly, however, it can be resolved to improve your credit.

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Student Loan Rehabilitation

Student loan rehabilitation may be available for federal loan borrowers who have defaulted on loans. This is a process in which you agree on a payment amount and then make nine payments over a period of ten months.

Tayne says, “Before you negotiate any settlement, it is a good idea to try to rehabilitate the federal student loan to get them out of default.” If you are able to do so, the default will be removed from your credit report. This will increase your credit score. To make monthly payments more manageable, you can apply for an income-driven payment plan.

Income-Driven Repayment Programs

You can apply for an income-driven payment plan if you are not yet in default on your federal loans but have difficulty paying your monthly payments. Your repayment term will be extended if approved and your monthly payment calculated on a percentage of your discretionary income.

Other payment options

Although private loans may not have the same benefits and processes as federal loans they might be able to help you if you contact your lender.

Tayne says, “If you have student loans private, get in touch with your servicer to find out what assistance they can provide.”

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Counseling for Debt

For free or low cost assistance, contact a non-profit credit counselling agency if you need assistance in negotiating with your lender. A debt counselor will assess your situation and help you develop a plan to repay the loans.