Fact or Fiction: Can I payoff my student loans with a lump sum?

Michael Lux Blog, Student Loans 30 Comments

Smart 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 count the loan as being paid in full?

Settlements for pennies on the dollar do happen. Unfortunately, this practice is more common for medical debt than it is for student loans. The biggest reason is that bankruptcy is much more difficult for student loans. Lenders know that borrowers have little choice but to pay the debt back in full.

That being said, there are limited circumstances where a lump sum payoff can work…

A Student Loan Partial Payoff Example

Suppose you have $30,000 in student debt and will be paying it off for the next 25 years. If you are fortunate enough to have access to $22,000, you may wonder if your lender would be willing to take the cash up from and call it even. In some ways, the transaction makes sense for both parties. You pay way more than what is due, but you save money over the life of the loan. The lender gets a ton of cash much earlier than they expected.

Win-win, right?

Let’s Make a Deal Doesn’t Work

The problem with this approach is that it runs counter to how lenders think and plan. The exact amount of money in the lender’s bank account at the present time is not the lender’s biggest concern. They are usually thinking long-term. 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. Reducing principle is just you returning the money they gave. Collecting interest is how lenders make money. (This is why negotiating a lower interest rate is usually easier than arranging for a loan payoff.)

A lender accepting a large partial payment instead of the full balance doesn’t make business sense. They don’t want the money back right away. They make money on interest and fees, so from their perspective, you settling your debt isn’t a win for them.

As a result, if you call your lender, no matter how persistent you are, you will almost never be able to negotiate a settlement. The best you can do will likely be to pay off your balance in full. Even if it doesn’t seem like a win, it is huge for you. By paying off the loan sooner rather than later, you avoid months or years of interest payments to your lender.

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.

The detail that is usually left out in these stories is that the borrower in question was way behind on their loans and severely in default.

In this limited circumstance, lenders are willing to play let’s make a deal. Why? They may realize that this is a debt they may never collect on. If they have the option of X dollars today or possibly zero dollars in the future, they will take X dollars today.

If you are caught up on your student loans, your lender knows there is a high probability that they will be able to collect the debt in full… so why would the negotiate a lower payment?

Beating the system

There is definitely the temptation to try to get clever, and instead of making payments on your loans, saving the money. As time passes, you can amass a huge settlement amount, and your lender can start to get desperate. After the loan has been in default for a while or when the lender is on the brink of taking you to court, you then make your offer.

This approach is incredibly dangerous and could cost you far more money in the long run.

For starters, it will ruin your credit score. While credit score may be just a number, it can mean the difference in owning a house vs. renting. It also dictates the interest rate in any loans that you may acquire. A good credit score has real financial value, and throwing it away for the chance to save a few bucks is a bad idea.

The other thing to remember is that while you are not paying and trying to scare your lender into settling, your balance continues to grow. Interest accrues daily and your balance increases. Plus, the late fees pile on. Each missed payment triggers more late fees. Falling off the student loan grid long enough to scare your lender into a settlement will also mean your balance is dramatically higher than what you started.

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

There is no trick or shortcut to use this money to get your entire debt off the books. If you have enough money to pay off most of your student loan balance, send in the big check. It won’t get rid of your loan entirely, but it will put a huge dent in what you owe. It will also mean much less interest for your lender each day. It may not be your ideal situation, but it is much better than just paying exactly 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.

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 huge step forward.