Guest Post: Putting an End to Default

By Pat Smith

The time has come for a new era in federal student loan policy — one in which students can borrow fully confident that their loan payments will be manageable when they leave postsecondary education.

In theory, we should already be there. Flexible repayment options are widely available in the federal loan programs. And starting this fall, all borrowers with economic hardship — no matter whether they borrow through the Federal Family Education Loan (FFEL) or Direct Loan programs — will have the option of repaying their loans as a percentage of their income. After 25 years, the federal government will forgive any remaining debt.

But we’re not there yet. Unfortunately, we’re not even close. According to the U.S. Department of Education, more than 200,000 of the 4 million student loan borrowers who entered repayment in the 2006 fiscal year were put into default status. While the problem is particularly bad at for-profit colleges and trade schools, it is not confined to one sector; 25%, or 50,000, of these defaulted borrowers had attended public four-year institutions. And while the new Income-Based Repayment program may reduce these numbers somewhat, we’re not expecting any miracles.

The truth is that many student loan borrowers are not told or helped to fully comprehend the full array of repayment options available to them. Nor do many of them realize the full range of penalties for defaulting on federal student loans, including the fact that there is no statute of limitations on federal student loan debt once it goes into default or that this debt can’t, for the most part, be erased in bankruptcy.

At the American Association of State Colleges and Universities, we believe that the only way that the federal government will be able to move past “default” is if it takes a much more active role in helping struggling borrowers manage their debt loads. In addition, we believe that the government needs to put an end to abusive private collection practices that put defaulted borrowers into a damaging debt spiral.

To this end, we have offered, in our 2009 Public Policy Agenda, the following three proposals:

Helping Delinquent Borrowers

The U.S. Department of Education should take a more substantial role in addressing loans that are past due but not yet in default. Currently, the Department cannot claim FFEL loans until after they default and lenders have been reimbursed by student loan guaranty agencies for their losses on the loans. Under our plan, lenders holding delinquent loans could assign them to the Department prior to the 270-day default trigger. Department officials could then use borrower income data from the Internal Revenue Service (IRS) to work out an appropriate repayment plan with the borrower.

Working with Borrowers in Default

For loans already in default status, current policy is an unnecessary hurdle for low-income borrowers. The only ways in which borrowers in default now can escape that status and have access to the full range of repayment options is to “rehabilitate” the loan (requiring the guaranty agency to find a lender who will buy the loan), or to consolidate the defaulted loan into the Direct Loan program. Only then can they have access to Income Based Repayment (IBR), Income Contingent Repayment (ICR) or the full range of other manageable repayment options. But the rules governing rehabilitation and consolidation are overly complex and guaranty agencies often administer these procedures more strictly than is required. As a result, borrowers’ efforts to get themselves back on track often are derailed.

Under our plan, all defaulted loans would automatically be assigned to the Department of Education, which would help financially distressed borrowers enter a repayment plan that takes account of their income. The Department could use contractors to collect loans in accord with this revised goal. Congress or the Department could set up standards by which the default record is expunged without maintaining the cumbersome “rehab” process.

Establishing fair treatment for defaulters would not handicap the government in collecting loans from borrowers with sufficient resources to repay. The Department would maintain the authority it has to attach wages or sue defaulted borrowers in court.

Ending the Debt Spiral

A borrower’s rights should not disappear when a collection agency holds his or her file. Under current policy, when a collection agency begins collecting on a loan, the borrower is no longer able to postpone payments. Instead, the whole loan becomes due. Even borrowers that wish to make payments or exercise other rights are often shut out because of problems with overly aggressive and often abusive collection agencies.

Federal loan policy should be altered so that borrowers would be responsible for what is due and manageable instead of adhering to a practice of declaring the entire loan to be due and payable. Such a policy change would help borrowers address their past due status and mitigate the accumulation of excessive collection charges and fees when collection agencies are able to assess penalty fees based on the entire loan rather than just the payments that are due. The Department would be allowed to contract with many groups, including collection agencies, to get delinquent and defaulted borrowers to understand the repayment plans available to them. However, it should not be allowed to routinely hand problem loan portfolios off to these agencies.

With the Obama administration and Congress considering proposals to restructure the federal student loan programs, we believe that it is absolutely vital that they take the steps necessary to put an end to default in the federal student loan programs once and for all.

Pat Smith is a senior federal policy consultant at the American Association of State Colleges and Universities (AASCU). Before joining AASCU, she served as the student loan examiner at the White House Office of Management and Budget from 1993 to 1997. She has been an expert on student aid policy for more than 35 years. Her views are her own and do not necessarily reflect those of the New America Foundation.