A reader has already decided to settle his debts for less than he owes. The only question is: How much less?

Question: : I have $88,000 in private student loan debt. I’m six months behind on the monthly payment of $865. So I have offered a settlement of 50 percent ($44,000) of what I owe. They have counter-offered at 61 percent, which is $53,770. 

I have paid more than $18,000 over the course of the last four years in a reduced-interest-rate program, after exhausting all deferments and forbearances. So now I have two questions…

First, should I take the 61 percent as the final offer? I have read 50 percent is very common in similar cases as mine.

Second, if I settle will I owe in taxes next year? And if so how much? I realize my credit will be hit pretty hard. I can endure that, but how much I owe in taxes could make a huge difference on whether or not this is a smart move.

— Aaron in Missouri

Steve Rhode answers…

Debt settlement is nothing more than two parties coming to a mutually agreeable arrangement to resolve a debt owed. Here’s a quick explanation of what it involves…

A lot of factors go into trying to determine if a settlement is a good offer. Some of those factors can be:

  • Who’s the lender or servicer?
  • What’s their track record on taking legal action?
  • Do they offer better settlements after filing suit?
  • What’s their historical settlement target?

Many of these answers can only be known by a professional who has experience dealing with the lender or servicer you have. This is why hiring a debt coach with knowledge and skills in this area can be invaluable.

Hiring someone to help you will cost you, so at some point, a lower actual settlement plus fee will equal an amount close to what you’ve been offered.

But let’s look at the facts. There doesn’t appear to be any dispute you owe the debt. So the current balance of the debt is determined by the amount borrowed and the terms agreed to in the original lending document.

Those terms probably said interest would continue to build even during periods where you were not making a payment. It probably says penalties can be added if you default and the lender has the right to take legal action to recover the money due.

This could include suing you and going for a judgment, garnishment, asset seizure, etc. Letting the situation continue if that might be your lender’s typical approach has some risk costs as well.

Here’s the most important thing to know…

No lender has to agree to any settlement.

So any agreement that’s different than what you currently owe is a benefit to you. Putting this behind you has some value to you as well. All of the above factors need to be weighed in determining what is a fair settlement amount for you.

The tax question

If more than $600 is forgiven in the settlement, the lender is required by the IRS to report the debt. Your tax exposure will be the amount of debt the lender agrees to write off.

However, if your liabilities exceed your assets at the time of the settlement, you may not have any tax liability. See IRS Form 982 to understand why you may not have any tax liability.

If you’re not insolvent and will owe taxes, then the debt forgiveness income will be at your normal tax rate — just like you earned the money.

Steve Rhode is known as the Get Out of Debt Guy and has appeared on FOX, CNN, ABC, NBC, and MSNBC giving money advice.


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Debt.com’s writers are journalists, personal finance experts, and certified credit counselors. Their advice about money – how to make it, how to save it, and how to spend it – is based on, collectively, a century of personal finance experience. They’ve been featured in media outlets ranging from The New York Times to USA Today, from Forbes to FOX News, and from MSN to CBS.


Steve Rhode

The Get Out Of Debt Guy

Published by Debt.com, LLC