Savvy borrowers are always looking for opportunities to save money on student loan payments. One common reader question looks something like this:

I owe $15,000 on my student loan. If I’m able to pay my lender a lump sum of $10,000 now, is there a way to get them to accept the loan as being paid in full?

It’s true that debt settlements, when debts are settled for less than what’s owed, do happen. However, this practice is more common for medical debt than it is for student loans. Probably the biggest reason for this is that bankruptcy is much more difficult to obtain for student loans. Lenders know that borrowers have little choice but to pay back the debt in full.

That being said, there are limited circumstances in which a lump sum payoff can work.

A Student Loan Partial Payoff Example

Suppose you have $30,000 in student debt to be paid off over the next 25 years. If you suddenly had an extra $22,000, you may wonder if your student loan lender would be willing to take the cash up front and call it even. In some ways, the transaction makes sense for both parties. You pay way more than the amount that is currently due, but you save money over the life of the loan. The lender receives a significant payment much earlier than they expected.

Win-win, right?

Let’s Make a Deal Doesn’t Work

The idea of settling your student debt with a lump sum payment seems practical from a borrower’s perspective. This approach runs counter to how lenders generally operate, though. The exact amount of money a lender currently receives from the borrower is not the lender’s biggest concern. Instead, lenders are primarily focused on the long-term return they can generate from a loan.

Collecting principal is how lenders recoup the money they lent you. Collecting interest is how lenders make money. A lender accepting a large partial payment rather than the full balance just doesn’t make good business sense from their perspective. Furthermore, because they make money on interest and fees, not collecting any more interest or fees isn’t a win for them, either. It is the reason that your lender wants you to pay the minimum over the life of the loan rather than paying it off quickly. This is why negotiating a lower interest rate is usually easier than arranging for a loan payoff.

If you approach your lender with a proposal to settle, you are unlikely to succeed in significantly reducing the debt outright. The most feasible action is often just to pay off the existing balance in full. While this may not feel like a victory, paying off your loan early is still beneficial for you as it prevents additional interest from accruing, potentially saving you money in the long run.

But wait… I’ve heard of people settling their debt for less than they owed.

The stories you have heard are true. From time to time, people do settle their student loan debt with a lump sum for a fraction of what they owe. A key detail that is often omitted from these stories, however, is that the borrower in question is usually delinquent on their loans and deep in default when these settlements occur. The negotiation normally takes place between the borrower or their attorney and a collection agency rather than the original lender.

In such scenarios, lenders may be more open to negotiation because they face a real risk of not recovering any money at all. Faced with the choice of receiving a definite amount now or potentially nothing later, they often choose the immediate payment.

For borrowers who are up to date on their loan payments, the situation is different. Lenders see these borrowers as low-risk, expecting to recover the full amount over time. Therefore, they have little incentive to settle for less.

Beating the System: Using a lump sum payoff to eliminate a student loan

There is definitely the temptation to try to get clever. The idea of deliberately delaying student loan payments to save up a large settlement amount can seem appealing at first glance. This strategy involves letting the loan go into default, then offering a lump sum when the lender becomes eager to settle as they approach potential legal action.

However, this approach is fraught with substantial risks and can end up being much more costly than it appears.

One of the immediate consequences of not making loan payments is the damage to your credit score. While a credit score may be just a number, it can have a significant impact on your financial plans. For example, it can mean the difference between owning a house versus renting. It also dictates the interest rate of any loans that you may acquire. A good credit score has real financial value. Throwing it away for the chance to save a few bucks is a bad idea.

Another critical issue is the accumulation of debt. When you stop making payments, interest on your student loans continues to accrue, increasing the total amount you owe. Late fees add up with each missed payment, further inflating your debt. By the time you propose a settlement, the total debt could be significantly higher than the original amount due to these added costs.

Thus, while it might be tempting to try to manipulate the system by saving up for a lump-sum settlement, the potential long-term costs, including a ruined credit score and a much larger debt burden, make this strategy highly risky. It’s generally safer and more financially prudent to maintain regular loan payments and explore other repayment or forgiveness options that don’t jeopardize your financial health.

I have a huge chunk of change, but not enough to pay off the loan… so what do I do?

While it might be tempting to look for a loophole or quick fix to eliminate your student loan debt with a large sum of money, such strategies rarely exist.

If you have a substantial amount of money available and are considering using it to reduce your student loan debt, send in the big check. This won’t clear your debt entirely, but it will significantly reduce the principal amount owed. Lowering the principal means you’ll accrue less interest daily, which can save you a substantial amount in the long run. A partial payoff may not be the perfect solution, but it’s far more beneficial than sticking to what your lender wants each month.

However, before making that huge payment, be sure to consider other financial goals like retirement, an emergency fund, and buying a house.

Ultimately, even though most borrowers will not be able to get their debt wiped away with a partial payment, they can still make a huge dent in the interest that is working against them on a daily basis. It isn’t the ultimate goal, but it is a big step forward.

The post Fact or Fiction: Can I payoff my student loans with a lump sum? appeared first on The Student Loan Sherpa.