Obama Ends Damaging Student Loan Collections Policy – But Needs to Do More

Borrowers with defaulted federal student loans received a rare bit of good news last week: the Obama administration put an end to a policy that improperly enticed loan collection companies to demand excessive payments from borrowers to “rehabilitate” their loans.

Starting this month, the U.S. Department of Education is providing a flat rate commission to the nearly two dozen firms with which it contracts to collect on defaulted loans. These companies will now make the same amount of fees regardless of whether they get a borrower to pay back $5, $50, or $250 per month.

Under federal law, borrowers who default can rehabilitate their loans if they make nine “reasonable and affordable” payments on-time over ten months – clearing their credit records and making them once again eligible for federal student aid. The statute bars collection agencies from demanding minimum payments based on the original loan amounts. Instead, they are supposed to take a borrower’s financial circumstances into account when determining how much that individual can handle each month.

The Education Department’s policy, however, encouraged collectors to demand larger payments than borrowers were legally obligated to pay. According to Bloomberg News, which was the first to report on the Department’s changed policy, here’s how it worked:

Under the old contract, the companies received a much higher commission if borrowers made a minimum payment of 0.75 percent to 1.25 percent of the loan each month, depending on its size.

For example, a $20,000 loan would require payments of about $200 a month for the collection company to get its full commission. Then, the collector would receive 16 percent of the loan amount – or $3,200. If the payment fell below that figure, the collector got an administrative fee of $150.

That differential provided an incentive for collectors to insist on the amount triggering the commission and fail to tell borrowers they could pay less…

In other words, the Department’s policy encouraged collectors to demand payments from borrowers that, in many cases, were neither reasonable nor affordable.

The Obama administration certainly deserves praise for ending this deeply misguided policy. The change should make it substantially easier for borrowers in default to get back on track with their loan payments – a win-win for these individuals and taxpayers alike.

But the administration should also recognize that its job is only half done. Private collection agencies responded to the incentives provided by the previous policy and hounded borrowers for payments they couldn’t possibly afford to make. As a result, many of these individuals had their wages garnisheed and their tax refunds and other federal benefits seized.

Don’t these borrowers deserve relief? At the absolute least, the Education Department should give these individuals a second chance to rehabilitate their loans with payments based on a percentage of their income. In the meantime, any collection costs that have been added onto their debt should be erased, and any wages that have been garnisheed and benefits seized should be returned.

The Department of Education’s policy did untold damage to countless borrowers. The administration must acknowledge the harm that has been done and figure out how to make things right.