The graduating class of 2015 has more student debt than any class in history — an average of $35,000 per borrower for the 71 percent of students who take out loans. The average debt has doubled over the last two decades, and rising defaults and reduced household formation have created concern, even in a good economy, where a college degree can fetch higher wages. Overall, outstanding student debt totals $1.2 trillion, more than any other obligation except for mortgages, and 8 million debtors are in default.
This has made students an inviting target for predatory companies who abuse the repayment process to maximize returns. The Consumer Financial Protection Bureau opened a formal investigation yesterday that will hopefully shut down this cottage industry.
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CFPB announced a public inquiry into student loan servicers, the companies responsible for day-to-day management of the debt. These private companies inform students of repayment options, manage borrower accounts and collect monthly checks.
As I’ve written before, these servicers should not exist. Most student loans these days are written by the federal government, which surely knows how to collect money. The U.S. maintains the largest collections agency in the world: the IRS. Yet we outsource student loan servicing to companies that repeatedly break the law.
In the past couple of years alone, servicers have, among other activities:
- illegally blocked payments from accruing to loans with the highest interest rates
- prevented borrowers from learning about cheaper repayment options
- overcharged active-duty members of the military
- violated discriminatory lending practices
- pushed debtors into plans that increase their overall burden
- and harassed borrowers after their co-signers died (even if they were current on their loans).
Servicers have been fined hundreds of millions of dollars to resolve federal investigations.
But the Education Department has yet to drop badly performing student loan servicers, though it has authority to do so. In fact, under a revamped contract, servicers are actually paid more, in the name of strengthening incentives for limiting defaults. Last year, the Obama administration created a process to directly communicate with borrowers about repayment options rather than rely on servicers.
If you’re end-running the companies with the contract, why have them at all?
Servicer incentives to cheat borrowers can outweigh the Education Department’s best intentions. For example, Tasha Courtright, a student at the for-profit Everest University in Ontario, California, came out of college with $31,000 in loan debt. She gave birth to a daughter with Down Syndrome, and had to take off time from work to care for her. So Tasha called her loan servicer, Sallie Mae (now known as Navient), seeking relief.
They told Tasha the only option was forbearance, a process where loan payments get deferred for a short period, so she took it for a year. But despite pausing payments, interest continued to accrue on the debt. By the end of the year, Tasha owed $41,000, a 33 percent increase.
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Tasha later learned that she had the right to income-based repayment, a system expanded by the Obama administration that ties student loan payments to earnings. Since she had no income, she would not be charged for loans. “I asked Sallie Mae, Why didn’t you tell me about this?” Tasha said. “Their answer was, ‘Sorry you got the wrong information from somebody.’” But it was the right information for Sallie Mae, which earned thousands of dollars from Tasha by ignoring the income-based repayment option.
This is the type of profit-maximizing behavior CFPB wants to investigate. In its “request for information,” the agency wants to learn about “economic incentives affecting the quality of service,” along with specific industry practices that harm distressed borrowers. “Today’s public inquiry requests information on whether servicers’ policies and procedures are resulting in struggling borrowers paying more fees or prolonging repayment,” CFPB said in a statement.
The agency already has a head start. CFPB previously conducted oversight of student loan servicing and found a bevy of problems. “At every stage of the process,” said CFPB Director Richard Cordray at a field hearing yesterday in Milwaukee, “borrowers have told us they are wrapped in mounds of red tape.” Inconsistency of information, delays in getting payments processed or fixed, and difficulties when servicing rights are transferred tend to dominate the process.
These problems are analogous to what we have seen in other servicing industries, and CFPB wants to determine whether it should enact comprehensive, industry-wide regulations, the way it has on credit card and mortgage servicers. That could be a positive step, with the agency focused on consumers taking the reins of oversight from the Education Department, which critics believe has not followed through for students.
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But given that most student loans, unlike mortgages and credit cards, are directly issued by the government, there doesn’t seem to be much reason to keep predatory servicers in business, let alone fattened up with hefty contracts.
There are open questions about whether the government has the legal authority to fire servicers and collect on student loans itself; it comes down to this legalese, and whether the Secretary of Education thinks it’s “practicable” to give contracts to companies who defraud their customers. Even an Education Department attorney says they have flexibility on this point.
Indeed, the Treasury Department began a pilot program this year to directly service delinquent student loans, raising the question of whether the government should stop contracting the work out to private debt collectors. And the Department of Education recently terminated contracts with some debt collection agencies (though this was somewhat misleading, as it merely ended contracts that would soon expire).
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Strong rules from CFPB cracking down on servicer abuse could actually turn this into a self-fulfilling prophecy. If the servicers see no value in student loans because the potential profits from screwing borrowers have been squeezed out, then they might stop bidding on the contracts. And it would no longer be “practicable” to find private student loan servicers, leading to taking the business in-house.
Obama announced a Student Aid Bill of Rights back in March, with more protections for borrowers, specifically on loan servicing. CFPB is trying to help fulfill that goal. It would be nice if we got to the real solution, and stopped outsourcing duties the public sector is completely well-equipped to perform.
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