Federal Student Loan Settlements: What’s Changed, What’s Still Possible
What is a Federal Student Loan Settlement?
If you are researching options for a federal student loan settlement, it’s important to know upfront – it’s a rare and tightly regulated process. It’s also important to know that information about entering into a federal loan settlement is difficult to obtain and the process can be murky. While this is the most up-to-date information, it may change.
Let’s start with a definition.
A federal student loan settlement, or compromise, is an agreement between a borrower and the U.S. Department of Education (ED) to accept less than the full amount owed to resolve a defaulted student loan balance.
Unlike private loan settlements (which we cover in a separate blog post), federal loan settlements are regulated by federal law and are governed by the ED’s internal policies.
How Settlements Work Under Federal Law
The ED can only consider a settlement after a borrower has defaulted on their federal student loan(s). A borrower is considered in default if they fail to repay their loan in accordance with the terms agreed to in their loan’s promissory note. While the default point varies depending on the loan type, most federal loans enter default if a payment has not been made in more than 270 days.
Once a loan is in default, the ED will pursue collection efforts as required by federal law. This can include the withholding of wages, federal income tax refunds and other federal payments such as Social Security or Social Security Disability benefits.
Once a loan is in default, conversations may begin with a loan servicer and the ED (or its collection representatives) about settlement. Most collection agencies working on behalf of the ED will not discuss settlement without first discussing:
- Loan Consolidation: ED servicers or representatives may seek to consolidate multiple loans into a single loan with a fixed interest rate.
- Loan Rehabilitation: ED servicers or representatives may seek to rehabilitate a loan, which removes it from default status. (Please see the Rehabilitation sub-section below for detailed information).
If rehabilitation or consolidation is not possible or not successful, only then may a collection agency escalate a settlement request to the ED. Loan servicers and collection agencies can NOT negotiate a settlement, that occurs through the ED’s Default Resolution Group.
Why Settlement is Not a Standard Repayment Option
Unlike the process for applying for a federal student loan, there is no formal application for a federal student loan settlement. Discussions typically start with the collection agency representing the ED, which then reviews a borrower’s income, expenses, and other supporting documents to determine if a settlement is justified.
If the collection agency believes a settlement may be possible, they can propose one of the few limited settlement options allowed under federal law. These settlements do not forgive the entire loan balance and may require the borrower to pay a reduced principal or interest amount. The proposal is then sent to the ED’s Default Resolution Group for further review and approval. If a settlement is approved, the ED will typically require a lump sum payment within a specified timeframe.
This process is often confusing, and clarity on the rules and regulations can be hard to come by. A borrower trying to navigate it (while having their wages garnished) may experience intense financial stress, and as such, this path is not typically recommended as a standard repayment option for federal student loans.
Federal Student Loan Settlements
Now that we’ve covered generally how the settlement process works and why it’s rare, let’s review some of the details, qualifications, settlement types and what borrowers can generally expect. Again, it’s important to note that information on this process is not readily available; it can and will change at the ED’s discretion.
Who Qualifies
Borrowers with a loan in default and with a documented history of financial hardship may be considered for a settlement; however, there is no standard qualification process. There are also no published standard qualification metrics.
Settlement Types
Federal settlements typically fall into two categories: standard and discretionary.
- A standard settlement may involve waiving collection fees or accrued interest, but does not typically include reducing the principal balance.
- A discretionary compromise may involve the ED accepting less than the full amount owed with a lump sum payment.
Typical Discount Ranges
Discount ranges will vary based on a borrower’s financial profile, and the total amount of their loans. Generally, however, discounts are modest. Borrowers may be offered partial interest reduction, collection fee waivers, and possibly small reductions to principal. Even these modest offerings will require extensive documentation to support a borrower’s claim that settlement is the only viable option.
Pros and Cons
The pros of a federal settlement may include:
- The end of a default status.
- An end to collection efforts (and possibly collection fees) once the settlement is paid.
- Closure of a student loan debt.
The cons may include:
- A required lump sum payment.
- Negative impacts to a credit report.
- Continued collection activity during negotiations and a potentially lengthy, complex process.
How Federal Loan Policies Have Changed Under OBBBA
When the One Big Beautiful Bill Act (OBBBA) was signed into law on July 4, 2025, it changed many rules regarding federal student loans. While OBBBA did not directly modify federal settlements, it’s important to understand the changes as they relate to repayment plans overall.
Summary of Policy Changes
Under the OBBBA, many federal student loan programs and repayment plans were either overhauled or eliminated. This means borrowers seeking to obtain new federal loans may have limits on borrowing, and certain borrowers may have access to a smaller pool of repayment plans.
What Used to Be Allowed
Prior to OBBBA, eligible borrowers could enroll in federal repayment plans such as PAYE, REPAYE, SAVE, and ICR. These plans generally offered more flexible terms and repayment options. These plans are being phased out, and current borrowers on these plans will need to select a new plan by July 1, 2028. Borrowers who do not select a new plan may automatically be enrolled in the new Repayment Assistance Plan (RAP), though final RAP regulations are still pending and details may change.
What Is No Longer Permitted
Following OBBBA, there are several new restrictions that are effective as of July 1, 2026:
- Graduate PLUS loans are no longer offered to new borrowers.
- Parent PLUS Loans are now capped at $20,000 per academic year, and a total lifetime cap of $65,000 per student.
- Graduate Unsubsidized Direct Loans will be capped for professional programs ($50,000 per year/$200,000 lifetime) and other graduate programs ($20,500 per year/$100,000 lifetime).
Impact on Borrowers
Overall, OBBBA shifted federal policy away from flexibility and toward standardized repayment options. Borrowers exploring settlement should still review the federal repayment programs that are still available, as they are still likely better options (and more predictable) than a settlement.
When and How a Federal Settlement Might Still Be Possible (Rare Cases)
Federal student loan settlements are extremely limited, however, the ED may consider a settlement if it determines that collecting the full balance of a federal loan is unlikely or not in the government’s best financial interest.
These scenarios are limited and usually involve loans where a borrower has experienced financial hardship that will not likely be overcome, or that cannot be resolved through one of the existing options such as a new repayment plan or loan rehabilitation.
The ED may consider a settlement when:
- A borrower has well-documented, long-term financial hardship: The ED or its representatives will review income statements, assets and other expenses carefully to determine if a borrower cannot make payments now or in the future, even with a repayment plan.
- The loan has been in default for a significant period of time: Long-term default combined with unsuccessful collection efforts may prompt the ED to consider other measures, such as settlement.
- All other remedies have been exhausted: Before settlement will be considered, the ED or its representatives will pursue loan rehabilitation, consolidation, or try to move a borrower to an Income-Driven Repayment Plan (see below for more information). If those measures fail, a settlement may be more likely.
Sweet vs. McMahon
Borrowers researching “federal loan settlement” may come across a reference to a court case titled Sweet v. McMahon, formerly known as Sweet v. Cardona and Sweet v. DeVos. While these cases do have impacts for some federal student loans, they are not related to federal student loan debt settlement due to default.
The Sweet cases are a long-running class-action lawsuit regarding Borrower Defense to Repayment (BDR) claims. BDR claims allow borrowers to seek forgiveness of their Direct loans (or loans that are consolidated into a Direct Consolidation Loan) if their school engaged in misconduct which harmed students. This includes misrepresentations or guarantees of a job following graduation, promised salaries or transfer credits to other schools. In terms of federal settlement, it’s important to know:
- Sweet does not create or expand access to federal settlements: Borrower-defense forgiveness is completely separate and unrelated to negotiating the payoff of a defaulted loan.
- Sweet provides relief only to borrowers who submitted BDR claims and meet specific criteria: If you did not file a borrower defense application, this case does not impact your loan.
- Sweet demonstrates how narrow and targeted relief is in the federal loan system: While some borrowers received forgiveness under the settlement, this was due to litigation and not a settlement or negotiation.
For borrowers researching settlement options, Sweet v. McMahon is best understood as a court-supervised resolution for a very specific group. If you believe you were misled by your school and may be eligible for borrower defense, please review the Borrower Defense Loan Discharge page on StudentAid.gov.
Alternatives to Settlement
Borrowers with federal student loans have significant federal protections, benefits and repayment plans available to them. Before pursuing a federal settlement, other options should be exhausted, many of which are affordable, predictable and easier to obtain than a federal settlement.
Income-Driven Repayment (IDR) Plans
IDR plans base a borrower’s monthly payment on their income and family size, not the loan amount. For some borrowers, payments on an IDR plan could be as low as $0 per month. IDR plans are also eligible for eventual loan forgiveness after a set number of qualifying payments. There are multiple repayment plans under the IDR program, each with different terms and qualifications. To learn more, please review the Income-Driven Repayment Plans page on StudentAid.gov.
The SAVE Plan
The SAVE Plan is currently a part of a federal lawsuit, and as such, may experience significant change. Due to court action on December 9th, 2025, the SAVE Plan may change in the following ways, pending final court approval:
- Not enroll any new borrowers in the SAVE Plan,
- Deny any pending SAVE applications; and
- Move all SAVE borrowers into available repayment plans.
As such, borrowers should not plan to enroll in this plan or to receive its benefits.
Fresh Start (Default Removal)
As of October 2, 2024, the Fresh Start program is no longer offered to new borrowers. For borrowers who enrolled in Fresh Start by the deadline, their terms, benefits and plans may still apply.
Rehabilitation
Loan rehabilitation allows borrowers to remove a federal default by making nine consecutive and reasonable monthly payments over ten months.
Under ED policy, a reasonable monthly payment for rehabilitation is determined either by a standard 15 % discretionary income formula or by an alternative amount based on a borrower’s documented income and expenses, which in practice may be lower than 15 % of discretionary income, depending on the borrower’s circumstances.
Per the ED, “Discretionary income is calculated as the portion of your adjusted gross income (from your most recent federal income tax return) that exceeds 150 percent of the federal poverty guideline for your state and family size.” Let’s look at an example of the discretionary income formula:
- Borrower John has an adjusted gross income (or AGI) of $45,000, and has a household size and state where 150% of the federal poverty guideline is $22,500.
- In this example, under the loan rehabilitation agreement, the monthly payment is 15% of discretionary income, divided by 12 (to calculate the monthly payment).
- At 15%, the annual amount would be $3,375, or approximately $281.25 per month.
After completing the payments, the loan becomes current again, and most collection activity stops. Rehabilitation also restores eligibility for federal benefits, including IDR enrollment. Because it can only be used once per loan, borrowers should confirm it is the right time to pursue this option. To learn more, please review the Getting out of Default page on StudentAid.gov.
Other Income-Based Options
Some borrowers may qualify for reduced-payment options through their loan servicer due to financial hardship. These options vary but can sometimes provide short-term relief while a borrower prepares to enter IDR, rehabilitation or consolidation.
Time-Sensitive Warnings
Some federal programs are only offered for a limited amount of time. For example, the Fresh Start program was only available from early 2022 to late 2024. Delaying enrollment could limit or eliminate options that are currently available.
The StudentAid.gov website features important news on the front-page banner; consider reviewing the website at least monthly to stay on top of news and offerings. To learn more, please review the Federal Student Aid homepage on StudentAid.gov.
Before Considering a Federal Settlement…
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Federal Programs
Beyond repayment plans, the federal government offers targeted programs such as Public Service Loan Forgiveness (PSLF), Teacher Loan Forgiveness (TLF), military benefits and discharge options for disability or school-related issues. These programs may result in full or partial forgiveness without requiring a default or settlement.
Consolidation
Consolidation allows borrowers to combine one or more federal loans into a new Direct Consolidation Loan. This can result in lower or simplified monthly payments and may restore access to federal forgiveness programs. There is no cost to consolidate federal loans, however, it may result in a longer repayment period, higher interest accrual and loss of some federal benefits such as interest rate discounts, principal rebates, or some loan cancellation benefits. To learn more, please review the Consolidating Student Loans page on StudentAid.gov.
Private Loan Refinancing Options
Refinancing a federal student loan with a private lender converts the loan into a private student loan. For some borrowers, refinancing a defaulted student loan may be a better option than a federal settlement. Refinancing may result in a lower, fixed-interest rate and a structured repayment plan to get out of default.
It’s important to know that private lenders have their own qualifications and hardship programs; once a federal loan is converted into a private loan, it may no longer be eligible for federal forgiveness or hardship programs.
Risks, Costs & Disadvantages
A federal loan settlement may come with certain drawbacks, and it’s important to fully understand them before moving forward.
Credit Impact
A federal loan settlement does not “fix” a borrower’s credit score. Because settlements are considered after a loan is in default, that means a borrower’s credit report may already show negative impacts. Late payments, collection activity and the default itself will all likely result in a lower credit score. The length of time these negative impacts will remain on a borrower’s credit report can vary, but seven years can be considered a general timeline.
Tax Consequences
In some cases, the IRS can treat forgiven debt (such as student loans or credit card debt) as taxable income (some federal student loan forgiveness is tax-free through December 31, 2025, under the American Rescue Plan Act). This means a borrower may incur a federal tax obligation for the amount forgiven, and possibly a state tax obligation, depending on the state. Federal and state tax obligations can vary widely depending on a borrower’s individual circumstances, and as such, a tax professional should be consulted before a settlement is final.
Debt Collection Activity
A settlement does not stop debt collection efforts until after it is final and paid. This means a borrower may have to experience garnished wages and aggressive collection efforts while working through the federal settlement process. There is no set timeframe for how long this process can take, but weeks and months are not out of the question. It’s important to know that collection efforts may also involve court proceedings, and a borrower may need to consult a legal professional as part of the settlement process.
Fees
Fees may be incurred as part of the federal settlement process. These fees may be waived or enforced during the settlement negotiations, and there is no established standard for their rate, however, fees in the 25% range are not abnormal.
Borrowers should be cautious working with private companies who offer “guaranteed” federal settlements with reduced or no fees.
Frequently Asked Questions
Still have questions? We’ve covered some of the most common below.
- What is the standard settlement amount? Federal settlements are rare and highly individualized. As such, there is no standard settlement amount. Every case is reviewed and decided based on a borrower’s unique financial situation.
- Can you negotiate a lump sum on federal loans? The answer is possibly. A lump sum payment is typically required if a settlement is approved, and the amount must be paid within a specified timeframe. During settlement negotiations, there may be an opportunity to request an adjustment to the lump sum amount, however, the ED is under no obligation to adjust it or accept a borrower’s proposed amount. A borrower cannot simply propose a lump sum payment to the ED to settle a federal student loan on their own. Rather, a lump sum payment can only be discussed as part of a settlement negotiation.
- Is a federal settlement right for me? The answer is maybe. Federal settlements may be worth pursuing for borrowers who have exhausted all other options, and who have access to cash reserves that are sufficient to settle their federal student loan(s) with a lump sum payment (if applicable).
- What is the 7/7/7 or 7-in-7 rule for debt collectors? This rule is part of federal regulation that restricts third-party debt collectors from potentially harassing borrowers, including some student loan borrowers. The rule generally limits collection agents to no more than seven contacts in seven consecutive days when using a single communication method (phone, email, text, etc.). However, if a borrower consents to receive additional communications, such as by saying ‘you can call me tomorrow,’ the limit resets. Borrowers may have additional protections depending on their state’s law.
Final Considerations
Federal student loan settlements are rare, and borrowers may achieve better financial outcomes through more standard repayment options, such as loan rehabilitation, consolidation, or income-driven repayment plans. A decision to move forward with a federal settlement should be made with thoughtful planning, and for most borrowers, should be a last resort.
For those seeking to understand all their options for defaulted federal student loans, please review the StudentAid.gov website.
While Yrefy does not provide help for federal loan settlements or refinancing for federal loans, we are able to help you navigate your private student loan options with confidence.
Yrefy specializes in working with struggling borrowers who have delinquent or defaulted private student loans, including those with bad credit. Eligible borrowers can receive fixed-rate refinancing, custom repayment plans and, in some cases, co-borrower release.
Want to speak with our team and explore your options? Apply online or call us at (888) 358-3359.
Disclaimer: This article is for informational purposes only and should not be considered legal advice. Always consult with a qualified attorney or financial professional regarding your specific situation.
