Guest Post: No Relief in Sight for Private Loan Borrowers

[Editor’s note: At a time when loan industry advocates and the news media are raising alarms about private student loan providers tightening their lending standards, we at Higher Ed Watch believe it’s important to remind readers about the dangers these high interest loans pose for financially-needy students. In this post, consumer advocate Deanne Loonin warns that these loans are particularly damaging because of the way they have been financed. In the weeks ahead, we will take a closer look at the tactics that some loan companies have used to erode key consumer protections for private loan borrowers.]

By Deanne Loonin

In my experience representing borrowers through the Student Loan Borrower Assistance Project, I have found that a great many borrowers who are in financial distress could get back into repayment if only lenders would work with them to modify loan terms or offer flexible repayment options. At the same time, I have also found private student loan providers to be universally inflexible in granting long-term repayment relief for borrowers. Even in the most severe cases, the creditors I have contacted have offered no more than short-term interest-only repayment plans or forbearances, during which interest on the loans continues to accrue. This experience holds true for both for-profit and non-profit lenders.

Lenders who refuse to offer help often say that they are acting in the best interests of borrowers, who will be harmed, they claim, if they make payments so low that they do not reduce principal. This is a good principle in theory, but not particularly practical for borrowers in severe financial distress, especially those facing long-term problems such as disabilities. Unfortunately, these borrowers have reached a point where they will not be able to repay their loan balances without substantial help and flexibility from their lenders.

Isn’t it in the loan providers’ interest to provide a helping hand? Don’t they benefit if they can ease borrowers, who otherwise will default on their loans, back into repayment?

For the most part, no. And the reason why not is largely because of the way these private loans are financed.

Securitization, the process by which lenders aggregate a large number of notes or other assets and then sell securities backed by those assets, has fueled the explosive growth in private student lending. To get the capital to make the loans, lenders must continually feed investors with new loans. As a result, private student lending has become very much a push market, where products are offered not only in response to consumer need, but also to fulfill investor demand. Loan products are developed for the repackaging rather than to provide the most affordable and sustainable products for borrowers.

The key component in the success of a securitization is the legal separation of the loans in a pool from the entity that originated the loans. The loans are isolated in a trust under the tight management of a trustee, who acts as a fiduciary for the investors in the trust. Servicers are restricted by the terms of the initial pooling and securitization agreements (PSAs) that create the pools and document the powers and duties of the servicers, as well as the limits of the servicers’ discretion. A common PSA, for example, gives some discretion in granting loan modifications, but requires the servicer to act in the best interests of investors.

As a result, securitization makes it difficult for financially distressed borrowers to get relief. Lenders don’t offer the types of flexible repayment options that are available in the federal loan programs because they appear to believe that doing so will affect their ability to sell their loan packages to investors. And for the most part, the servicers working for the trusts don’t have the flexibility, or the willingness to use the discretion they do have, to modify the loan terms or reach reasonable settlements with borrowers.

Securitization is part of an overall “atomization” of the lending process, where so many different parties are involved in origination and servicing that each party along the chain can deny responsibility. As the number of entities holding the loan grows, it becomes increasingly difficult for borrowers to know where to turn for relief.

Other factors compound this problem. Seeking to act in the best interests of investors and keeping a tight bottom line, many servicers avoid high quality problem resolution services because such services are expensive. Instead, servicers tend to use the popular and cheaper call centers and automated phone systems. It is very difficult for a borrower to get timely and accurate information through these systems. In many cases, it is impossible to even figure out who owns the loan and who has the authority to make decisions.

Expecting student lenders to step up and voluntarily resolve these problems won’t work. It hasn’t worked on the mortgage side either. Congress should act to curb the most damaging aspects of the securitization process and stop servicer abuses.

Kurt Eggert, a law professor at Chapman University and an expert on securitization, has offered solutions worth considering such as eliminating barriers that slow or reduce modifications, pressuring investors into agreeing to changes in PSAs that allow modifications, and inserting these types of clauses in future agreements. Other recommendations include mandating borrower access to a decision maker, requiring information and dispute resolution prior to default, and curbing servicer abuses.

Private loans are costly enough without making it impossible for borrowers to get relief when they need it. Some borrowers need a helping hand. We should not refuse to give it to them.

Deanne Loonin is a staff attorney with the National Consumer Law Center and the director of the center’s Student Loan Borrower Assistance Project. She focuses on consumer credit issues generally and more specifically on student loans, credit counseling, and credit discrimination. She is the principal author of numerous publications, including “Paying the Price: the High Cost of Private Student Loans and the Dangers for Student Borrowers.” Her views are her own and do not necessarily reflect those of the New America Foundation.