What lump sum should I offer to debt collectors to settle?

Like any other negotiation, you're better off to start low

By Erica Sandberg

Opening Credits

Erica Sandberg is a prominent personal finance authority and author of "Expecting Money: The Essential Financial Plan for New and Growing Families." She writes "Opening Credits," a weekly reader Q&A column about issues for people who are new to credit, for CreditCards.com. Ask a question. 'Opening Credits' stories

Dear Opening Credits,
I have $80,000 in private student loan debt (from law school), not to mention another $100,000 in Stafford PLUS loans. I had trouble paying my loans two years back, and the private lender wouldn't come up with a payment plan I could afford, so I defaulted. It went into collections and has been for two years. I am still current on the federal loans.

My father came into a lot of money recently and is willing to buy out the defaulted private loan in one lump sum in order to wipe it from my credit report. I know that collections agencies can settle loans paid in one lump sum for pennies on the dollar. What is a reasonable one-time lump sum offer, including the requirement that they remove it from my credit report? Obviously, it's negotiable, but what is the industry standard? Would 30 cents on the dollar be a good offer? Where does one start in negotiations like this? I know I need to get an attorney to represent me in the negotiations, but I would like some industry standards to work from. If they don't take a significant haircut, I have little incentive to settle it in a lump sum. -- Adam 

Dear Adam,
I think settling the defaulted student loan is a fine idea and definitely worthy of a try. Your dad is a gem to help you out.

However, hard numbers or percentages don't exist because every collection agency has its own policy.  Still, there are some guidelines I can share. Here's what you need to know and do.

That third-party company bought the account for a fraction of its true worth, and ideally would like you to pay the full balance. The difference between their purchase price and the amount you cough up is their profit margin. That purchase price, according to online debt auctions, can be as little as 2 cents to 4 cents of every dollar owed. Like any business, their aim is to buy low and sell high.

There is a good reason that a collector might agree to a lesser amount than is actually due. It's because the effort they put forth in getting you to pay is eliminated when you just cut a check. All those phone calls, letters and threats take time and energy, and their failure rate is high. By you sending at least a little more than what they spent, they come out ahead and can turn their attention to other pesky accounts in their system.

So how much is the perfect amount to begin negotiations? A key but unknown (to you) factor is the sum the collection agency paid for the account. If you had that information, you'd have a clear place to start. Problem is, even if you asked, they wouldn't tell you. So you have to guess, and it doesn't hurt to start low. Go ahead and offer 25 percent of the balance -- around $20,000. Explain that you are prepared to send a money order immediately, as long as they sign an agreement that secures the settlement. You don't need an attorney to draw up such a contract, but if you don't mind shelling out a few bucks for one it doesn't hurt to do so.

The collector will either jump on your proposal or reject it. If they say yes, send the agreement, have them sign and return it and then shoot them the money. In the event of a denial, increase your offer to a comfortable figure. With some back-and-forth bargaining, you can probably come up with a deal that both you and the collector can live with. But do keep in mind that they are under no obligation to accept anything but the complete balance. The ball is in their court, not yours.

Know, too, that walking away from a portion of your loan will save you some cash, but maybe not quite as much as you think. The IRS considers forgiven debt as income, so a bigger tax bill may be in your future.

As for your credit report, you were delinquent on payments and the debt was sold to a collection agency. Those are facts, and you can't have those notations removed before they "age off" your credit report seven years after the original loan holder charged off the account. Additionally, your reports will indicate that you've settled the obligation, which doesn't look quite as wonderful as satisfying it in full.

From here on out, keep your credit clean. Borrow prudently and pay according to the contract. 

See related: 1099-C surprise: IRS tax follows canceled debt, Negotiating debt with original creditor vs. 3rd party collector

Erica Sandberg's articles and insight are featured in such publications as the Wall Street Journal, Pregnancy, Babytalk, Redbook, Bank Investment Consultant, Prosper.com, MSNMoney.com, and Smartmoney.com. An active television and radio commentator, Erica is the credit and money management expert for San Francisco’s KRON-TV, a frequent guest on Forbes Video Network, Fox Business News, Businessweek-TV, and all Bay Area networks. Prior to launching her own reporting and consulting business, she was affiliated with Consumer Credit Counseling Services of San Francisco where she counseled individuals, conducted educational workshops, and led the media relations department. Erica is a member of the Society of American Business Editors and Writers, and on the advisory committee for Project Money.

Send your question to Erica.

Published: January 2, 2013

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