According to Politico, late Monday night, the Department of Education told a federal appeals court that a court order blocking its ability to send any newly defaulted student loan borrowers to its hired debt collectors has cost taxpayers more than $5 million in lost collections since March.
This lawsuit came about because private debt collection agencies that were not awarded the latest collection contract sued the Department of Education. After the judge overseeing the litigation issued an order preventing the Department from assigning new accounts to debt collectors, the Department announced a re-do of the contract and is now rushing to make a final award by the end of next week.
What the Department of Education failed to mention in its latest filing is that the debt collection contract is failing to serve borrowers or taxpayers. Rather than rushing to award this same contract, the Department should take this opportunity to create a system that actually helps student loan borrowers address their loans.
Objectively speaking, five million dollars is not a small amount of money. However, the Department pays its private collection agencies nearly a billion dollars annually. And most of that money is a total waste to taxpayers. According to a recent Bloomberg analysis, the Department pays its debt collectors nearly $40 for every $1 dollar they collect: meaning that for the collection agencies to collect $5 million, taxpayers would likely shell out almost $200 million in commissions. That’s a bad deal for taxpayers.
Arguably, the commission amount could be a good investment if it was helping direct borrowers into programs that turned these into performing loans. Aside from repayment in full or a loan discharge, most borrowers can cure a default of their federal loans through one of two programs: rehabilitation or consolidation. But as we found in our 2014 report, Pounding Student Loan Borrowers, which recent Consumer Financial Protection Bureau (CFPB) data confirms, collection agencies steer borrowers into rehabilitation programs because that program offers the highest commission rate to the debt collectors, despite leading to worse outcomes for borrowers.
According to the CFPB, the rehabilitation program, where borrowers make a series of payments in order to cure their defaulted loans, is not creating a sustainable path to student loan repayment. Over a third of borrowers who rehabilitate their loans will re-default within the first two years. In contrast, the vast majority (95 percent) of the reported student loan borrowers who chose to use federal loan consolidation to get out of default (taking out a new federal loan to pay off the defaulted one), are still in good standing a year out.
Nonetheless, under the contract that the Department is planning to award, it will continue to pay collection agencies $1,710 if they can get a borrower to complete a rehabilitation plan but only $150 if they work with a borrower to consolidate defaulted loans. This contract is bad for borrowers and should not be awarded.
The Department also claimed that as a result of the judge’s order, 463,000 borrowers are stuck in default limbo because they cannot get out of default by rehabilitating their loans, as that program is generally managed by the Department’s private collection agencies.
This claim belies the fact that the Higher Education Act provides student loan borrowers in default with a second way to get their loans back into good standing: consolidation. Although rehabilitation may not be readily available due to the court order, many of these borrowers could consolidate out of default. The Department’s brief fails to show why borrowers are unable to consolidate out of default. Moreover, according to the CFPB’s data discussed above, consolidation – which does not require collection agency involvement – has better results for borrowers.
The Department needs to find a way to help the 463,000 borrowers resolve their student loan defaults. However, entering into a long-term contract with the same old flawed incentive structure that harms taxpayers and borrowers is not the solution.