The Consumer Financial Protection Bureau (CFPB) Student Loan Ombudsman released a report today estimating that over a third of borrowers who rehabilitate their loans will re-default within the first two years. It further highlighted industry estimates that re-default rates could be as high as 75% over the entire life of the loans. This confirms one of our greatest fears – that programs designed to help student loan borrowers may actually put them in a worse position.
Loan rehabilitation is a program by which a federal student loan borrower is able to cure a loan default by making nine reasonable and affordable payments in a ten-month period. After making these payments, the borrower is able to access flexible repayment options, such as income-based repayment, which include potential loan forgiveness. The catch is that, since 2008, borrowers are only able to rehabilitate their loans once. This means that borrowers who rehabilitate and then re-default are no longer eligible to get their loans out of default through rehabilitation. Though borrowers are also able to consolidate some loans out of default, consolidation is similarly limited to generally one chance. Therefore, borrowers who re-default will often be stuck in default indefinitely—with no further chance to get back on track and in good standing. These borrowers will experience the draconian consequences of default, such as wage garnishment, seizure of their tax refunds (including their Earned Income Tax Credit), and offset of their Social Security benefits, potentially for the rest of their lives. This harsh “two strikes and you’re out” policy denies borrowers the opportunity to take control of their student loan debt after early struggles.
Based upon consumer complaints, the CFPB attributes this high level of re-default to ineffective loan servicing and inadequate counseling by debt collectors. Ineffective servicing has been a hot topic this year and this administration has paid a lot of attention to the problems borrowers face enrolling and staying in one of the income-driven repayment plans. Unfortunately, debt collection has not received the same level of scrutiny.
Debt collectors working for the Department of Education are paid a lot of money. Under the current contract, they are paid $1710 per successful loan rehabilitation. To put that into context, they are paid only $150 to help a borrower complete a disability discharge application or consolidate into an income-driven repayment plan. As we wrote in our 2014 report, Pounding Student Loan Borrowers, the Department’s compensation system rewards debt collectors for maximizing the dollars collected and for loan rehabilitations. We documented how this compensation system leads to violations of borrowers’ rights. In fact, when the Department fired five of its debt collectors last year for lying to student loan borrowers, it was precisely because of those debt collectors’ exaggerated claims about the benefits of loan rehabilitation.
Borrowers can rehabilitate their loans for as little as $5 per month, based upon their income, and the CFPB estimated that nearly 80% of rehabilitating borrowers are eligible to make a payment that low. Most of those borrowers would qualify for $0 payments in an income-driven repayment plan. The fact that they are not getting into those plans or not staying in them shows a major failure in the system. The CFPB estimates that failure to be extremely costly for borrowers, adding an unnecessary $125 million in interest charges alone.
Debt collectors are required to counsel borrowers about income-driven plans while rehabilitating their loans. Unfortunately, we do not have any data about the success rate of that counseling, nor will the Department of Education release an unredacted version of the Private Collection Agency Manual so that we can see how it has instructed its debt collectors. Nonetheless, the CFPB’s data show that the Department is paying over $1 billion to put a lot of borrowers in a worse position then when they started. That seems like a bad deal for the American taxpayer.
The CFPB also questions whether loan rehabilitation even makes sense anymore. This is an important question. The report observes that “legacy requirements in the rehabilitation program place increased burden on borrowers, increase costs for taxpayers, create unnecessary barriers to repayment success, and fail to consider the significant changes that have occurred in higher education finance market in the past decade.”
In our experience working with clients, very few choose loan rehabilitation as a method for getting out of default once they are given an accurate presentation of their options. (See here for a comparison of rehabilitation versus consolidation.) Most of the borrowers we work with choose the option of consolidating directly into an income-driven repayment plan. In the report of its debt collection pilot, the Treasury Department also showed more borrowers consolidating than rehabilitating.
Federal student loans are complicated and borrowers in default have many different options. Student loans have no statute of limitations – they can even be collected from Social Security retirement benefits. And there can be serious long term consequences if a borrower makes the wrong choice. The goal of working with student loan borrowers in default should be to inform and counsel borrowers about the full range of available options, and to facilitate getting the borrower into the right program for the long term based upon that borrower’s circumstances, not just to collect the most money in the short run or shoehorn everyone into the same program.
In light of this data, we renew our call on the Department of Education to eliminate the use of private collection agencies and move toward a comprehensive and individualized counseling model for student loan borrowers in default. At a minimum, the Department should reform the collection incentive structure so that payment is based upon borrowers’ long-term success.