The Default System Needs Reform on Many Levels

Borrowers reported defaulting for many reasons. They were financially insecure, their lives were complex, they struggled to navigate in systems not always designed with their needs in mind, and many were poorly served by the Department and its contractors. The much-needed and long-overdue suite of policies advanced over the last two years will greatly benefit students and borrowers. (See “Recent Initiatives that Benefit Borrowers in Default” for more information about these efforts.) But the Department must ensure it can implement plans and initiatives to support struggling borrowers before repayment restarts, and Congress and the Biden administration must provide more assistance and relief to those in default going forward.

Policy solutions must take families’ financial realities into account; be easier to access and understand, including being as automated as possible; and create an environment in which the Department and its contractors are held to high standards and work together to ensure that borrowers succeed in repayment.¹ The Department and Congress must design reforms that quickly address the current issues in the system, including by building on what is already in the works. They must also think about opportunities for large-scale change in the future and remedy past system failures.

Helping borrowers exit default and avoid redefaulting

Those in default must be able to exit more easily and quickly under consistent terms.

• Establish a fast, flexible pathway out of default that borrowers can use multiple times. Borrowers should be able to exit default at any time by enrolling in an IDR plan, without first having to consolidate their loans.
• Increase awareness about cancellation, Fresh Start, and other loan forgiveness and discharge programs. More than 26 million borrowers have already applied for the Biden administration’s loan cancellation initiative.² Through the application process, the Department will be in touch with many borrowers in default whose contact information it may not otherwise have on file. The Department should continue to use, and prioritize, the engagement opportunities created through cancellation to connect with borrowers who will have remaining balances post-cancellation about additional resources and opportunities to exit default and manage their loans. These should include existing discharge and cancellation programs, IDR, PSLF, and Fresh Start, which the Department should make as automatic as possible.

  The Department should provide contractors with guidance, resources, and oversight on direct outreach; engage in paid advertising; conduct outreach through social and news media; and work with community partners. The Department should also continue to explore federal, state, local, and employer data matches and proactive outreach to find those who might be eligible for relief.

• Expand access to and automatic uptake of forgiveness and discharge programs. Borrowers report not knowing about available loan discharge programs, preventing them from filing an application to receive relief if that is required. Before borrowers experience any consequences related to default, the Department and its contractors must first seek to make sure they are not eligible for loan discharges. These include those available when borrowers are defrauded by their schools, their schools close, or they become disabled, among others. While new regulations will make accessing these programs easier for many borrowers, where the systems are not fully automated, the Department must also use its authority to automatically process as many borrowers as possible and to catch borrowers before they enter default.
• Provide additional loan discharges for those spending lengthy periods in default or repayment or who remain eligible for means-tested government benefits over time. This should also be applied retroactively to ensure that those who are or have long been in default are given a clean slate moving forward.

Protecting the financial security of borrowers in default

Focus group participants described the consequences of default hitting them as they were managing other crises, which compounded their stress. The financial consequences of default must be less punitive.

• Ensure borrowers never pay more in default than they would in repayment, including under an IDR plan. Borrowers should have access to IDR while in default, and no payments—voluntary or involuntary—should exceed the amount borrowers would pay under an IDR plan. Limiting payments in default should also include limiting or eliminating the withholding of wages, tax refunds, and federal benefits and standardizing and reducing fees. (While time spent in default does not currently count toward forgiveness in any IDR plan, a new regulation may soon allow borrowers to access one of these plans while in default.³)
• Count time in default toward IDR and PSLF forgiveness. Relatedly, as it is implementing a recently announced account adjustment—which gives borrowers additional credit toward IDR plans (and related forgiveness)—the Department should, in contrast to its announced plans, give qualifying borrowers retroactive credit for time spent in default toward IDR and PSLF.
• Remove defaults from the credit history of any borrower who exits, not just those who rehabilitate their loans.
• Help borrowers manage growing balances in default. Once a loan enters default, interest should not continue to accrue or balances should not be permitted to grow.⁴ This is standard practice for other forms of credit.
• Create a statute of limitations on collections. Borrowers’ defaulted loans are collectable forever, so they may remain in the system for years longer than they would if they were in good standing on their loans.
• Increase bankruptcy protections for borrowers and ensure effective implementation of recent actions to streamline the process for borrowers seeking a discharge through bankruptcy.⁵ Currently, student debt is not dischargeable in bankruptcy except under extreme circumstances.
• Ban credit checks on employment and the practice suspending or cancelling professional licenses in some states when borrowers default on their loans.

Rethinking default

Over the next year, the number of borrowers in default could be decreased by more than half through cancellation, and that number could be potentially much larger through Fresh Start and various discharge programs. This provides an opportunity to rethink the system of default on a larger scale—and in a less piecemeal fashion—which could include streamlining the rules and processes between default and repayment, automating the system, improving accountability metrics, or eliminating the status of default altogether.⁶

Preventing defaults through reforms to the higher education and repayment systems

While reforms to the default system are necessary, a host of opportunities exist to help borrowers avoid default in the first place, including reducing or eliminating the need for loans, ensuring institutions are providing access to high-quality programs that lead to upward economic mobility, and reconsidering accountability around loan performance. In addition, Congress and the administration can:

• Effectively implement the Fostering Undergraduate Talent by Unlocking Resources for Education Act (FUTURE Act) to remove administrative barriers for borrowers trying to access IDR plans. This 2019 legislation directs the IRS to securely share borrower tax data (with the borrower’s permission) with the Department.⁷ The law could make it possible to automatically enroll delinquent borrowers, borrowers in longer-term forbearances, those exiting other periods of forbearance and deferment, and those exiting default into IDR plans.⁸
• Ensure that performance metrics, penalties, and incentives for contractors are aligned with desired borrower outcomes. The Department must provide strong oversight and continue to partner with other government entities to ensure its contractors provide consistent and accurate information and assistance to borrowers. It is also important that the Department provide consistent and adequate communication to contractors. As part of its plan for new servicing contracts, the Department must require effective outreach to the most vulnerable borrowers. This could include improving requirements for engagement at inflection points, particularly when borrowers enter repayment, miss payments, and enter and exit a paused payment status. Outreach to current borrowers is also needed when new repayment, discharge, or forgiveness options become available.