An American defaulted on a student loan direct from the U.S. Department of Education every 28 seconds over the past year. Nearly all of those more than 1.1 million defaults were avoidable, because almost every borrower is eligible for a repayment plan based on affordability.
Too few borrowers in distress know they can reduce their payments simply by sharing a few recent pay stubs or a copy of their most recent tax return. Something in the repayment system is clearly broken, and so last month federal education officials moved to scrap it—slowly. In a few years, the Education Department hopes, loan companies to which it outsources collections will prioritize showing debtors how little they can pay to remain current over collections.
Another part of the federal government agrees that something needs to change but disagrees about the multiyear timetable. The Consumer Financial Protection Bureau last week told those same collections contractors that the transition needs to happen now. It was a move the industry took as a threat.
The crux of the issue are federal income-based repayment plans, which allow just about all of the roughly 42 million borrowers with federal student loans to make monthly payments based on how much they can afford, rather than how much they owe. At a time when the total student debt balance in the U.S. is an eye-popping $1.4 trillion, income-based plans are meant to reduce the ranks of the one in four borrowers in arrears on student debt.
In a stinging new report (PDF), the consumer bureau's top student loan official said the nation's most vulnerable borrowers often face unnecessary hassles enrolling in these repayment plans. Loan servicers often take several weeks, sometimes months, to process applications that should be reviewed within 15 days. Applications are rejected without explanation, sometimes unfairly. Paperwork is frequently lost. And in a cruel twist, the Department of Education's loan contractors occasionally deny borrowers' applications because their circumstances change during the months it takes to process the paperwork. "Student loan servicers continue to fall short," said Richard Cordray, the consumer bureau's director.
As a result, millions of distressed borrowers risk falling further behind as their balances grow and they're forced to rely on temporary postponements that are normally meant to apply in financial emergencies. Borrowers can postpone their payments only a few times before they default. "Student loan servicing breakdowns can stack thousands of dollars of hidden costs on the backs of borrowers who can least afford them," said Seth Frotman, the consumer bureau's student loan ombudsman.
Kelly Leon, a spokeswoman for the Department of Education, declined to comment. Winkie Crigler, executive director of the Student Loan Servicing Alliance, a group representing companies that collectively collect payments on more than 90 percent of all outstanding student loans, also did not respond to a request for comment.
The CFPB has effectively become borrowers' main advocate in their battle against the Department of Education unit responsible for student loans and the department's contractors. It created a form (PDF) for borrowers to use when communicating with loan servicers. It is actively soliciting complaints from borrowers. The bureau even created a Twitter hashtag (#ApplicationAbyss) to drum up publicity about its concerns.
Frotman's report is the latest missive from a federal agency that increasingly is taking a harder line when it comes to the practices of student loan companies. Both the bureau and the Obama administration share the same goal: improved customer service and fewer loan delinquencies. But industry observers see the administration as more accommodating to the industry's needs, while the consumer bureau has made it clear that it's ready to sue. It's as if the Obama administration is using a carrot while the consumer bureau is brandishing a stick.
John L. Culhane Jr., a partner at Ballard Spahr who represents financial institutions in their dealings with the CFPB, said the bureau can sue any company that it determines uses unfair, deceptive or abusive practices against borrowers. Loan servicers "should view [the bureau's report] as what the CFPB expects to see" when it comes to their behavior enrolling borrowers in income-based repayment plans, Culhane said.
It's easier for the consumer bureau to use the threat of lawsuits to change industry practices than to formally draft new rules, generally a time-consuming process. The agency "has gotten increasingly more comfortable" using its enforcement authority to alter industry behavior, said Isaac Boltansky, an analyst in Washington with Compass Point Research & Trading. In this case, loan servicers "have to prepare for the most stringent requirements," Boltansky said.
That was the case earlier this year at Pennsylvania Higher Education Assistance Agency, said Leon, the spokeswoman for the Department of Education. A significant backlog meant the company wasn't meeting the 15-day deadline. The department pushed the company to reduce application processing times. Keith New, a spokesman for the company, which also does business as FedLoan Servicing, declined to comment. He cited the department's policy that it alone is allowed to publicly discuss federal student loan servicing practices.
With rare exceptions, the department generally has declined to publicly penalize its loan contractors. In fact, in some cases it has defended them in the face of criticism from other federal agencies. A quick review of the CFPB's website suggests it won't take a similar approach.