Strategic Default Does Not Save Money on Student Loans

Ben LuthiBy Ben LuthiBy Savingforcollege.com

Unless you qualify for student loan forgiveness, paying down your college debt is the best way to get rid of it. Even bankruptcy is unlikely to provide a solution.

As a result, you may be considering intentionally defaulting on your student loan debt to see if you can settle for less than what you owe. This practice is common with other types of debts, and there are several debt settlement companies who can help you do it.

When it comes to student loan debt, however, strategic default is not a good idea. Here’s why and what to do instead.


Why Strategic Default Won’t Help

If you’ve defaulted on your student loans, the U.S. Department of Education will typically refer your account to a debt collection agency. Collection agencies can offer three student loan settlement options without prior approval from the U.S. Department of Education, including:

  • A waiver of collection charges
  • A waiver of half of the interest accrued since you went into default
  • A 10% reduction of your balance

Unfortunately, none of these will save you money compared with keeping your loans in good standing. That’s because collection charges on defaulted student loans can add up to 25% of your combined principal and interest.

So even if you manage to get a 10% reduction of your principal and interest, collection charges can neutralize the savings.

A student loan settlement is mainly beneficial to borrowers who have been in default on their federal student loans for a decade or more, since it discounts the interest that has accumulated since the default. But, the U.S. Department of Education never settles for less than the loan balance when the loan went into default.

Thus, a student loan borrower who is current will never save money by defaulting on the debt.

What’s more, defaulting on student loans can ruin your credit when the collection agency reports the past-due account to the three national credit bureaus. If you plan to borrow money again in the near future, you’ll likely have to pay a higher interest rate. If your credit is bad enough, lenders may consider you too much of a credit risk and deny your application.

All things considered, a strategic default with student loans will likely cost you a lot more than if you were to continue making regular payments.


More Effective Alternatives to Strategic Default on Student Loans

If you’re struggling to get by with your current monthly payments or you’re looking for ways to get rid of your student debt faster, here are some better options to consider.

Student Loan Forgiveness or Repayment Assistance

The federal government, state and local governments, and certain employers can provide some help with paying down your student loan debt. Whether it’s assistance with paying down your balance or outright forgiveness, you may be able to get rid of a large amount of debt in a relatively short period.

Income-Driven Repayment Plans

The U.S. Department of Education provides income-driven repayment plans to reduce how much you pay each month. Your payment will be based a percentage of your discretionary income, which is determined by your income, family size, and state of residence.

Once you’re on an income-driven repayment plan, your repayment term will be extended to 20 or 25 years, after which any remaining balance will be forgiven.

Student Loan Refinancing

If you have great credit and a solid income, you may be able to reduce your monthly payment, interest rate, or both through student loan refinancing.

Just keep in mind that refinancing federal loans with a private lender means you lose certain benefits, including access to forgiveness programs and income-driven repayment plans.

Also, many student loan refinancing lenders offer variable rates that can increase over time, potentially costing you more over the life of your loan. Think carefully before you refinance and consider doing a fixed rate to avoid future fluctuations.


Defaulting Is Never Worth it

Some people default on their student loans because they’re experiencing severe financial hardship. But, if you can manage to make your monthly payments or you can take advantage of opportunities to lower your payment or get outside help, defaulting is the last thing you’ll want to do.

Not only will it likely cost you more to settle, but it can also destroy your credit, causing more problems in the long term. If you have other options available, use those first to get the relief or help you need.


NEXT ARTICLE