Improving the Administration and Collection Process for Government-Sponsored Student Loans

Introduction

Today, tens of thousands of young people are mortgaging part of their future with student loans in order to obtain a higher education. In some cases, these students do not receive the full disclosure concerning repayment terms, creating a long-term hardship. To determine the facts, this paper provides an overview of government student loans and how the different actors on the student loan side are involved with helping the student borrowers with loans need to be held to a certain standard. The problem that is occurring is that the student loan representatives are not revealing repayment options or answering questions when students call. Therefore, the purpose of this study is two-fold as follows:  1) to demonstrate that there is in fact a duty for these actors to provide full disclosure due to controlling legislation and 2) to identify potential outcomes in the event student-borrowers file suit in response to these violations. These issues have assumed new importance and relevant today because the stakes are particularly high as college tuition costs are rising and students are taking on more debt, and in turn more risk.

Background and Overview

Education loans are long-term funds that provide students and parents with the resources they need to pay for educational expenses. When people accept student loans, they are legally obligated to repay them according to the terms of the promissory note.2 Optimal loan arrangements for students and their parents are provided by Federal Direct Loans which are available irrespective of the amount of family income that is involved; but loans with the best terms are offered to students who are able to prove financial need.3  Generally speaking, federal loans provide students and their parents with superior terms compared to the majority of private or bank loans. For instance, the majority of loans from banks come with high interest rates and these loans do not contain the same provisions for deferment of payment that are provided by federal loans. By contrast, Federal Direct Loans can be deferred for repayment until borrowers are enrolled less than half time as undergraduates or graduate students.4 The U.S. Department of Education has a number of loan servicers that administer the student loans for the William D. Ford Federal Direct Loan (Direct Loan) Program as well as for loans that were completed originally pursuant to the Federal Family Education Loan (FFEL) Program but which are currently being serviced by the U.S. Department of Education.5

Despite the advantages of Federal Direct Loans, the Consumer Financial Protection Bureau (CFPB) has been encouraging lawmakers to revise the existing disclosure requirements of private student loan servicers to align their services with comparable reforms that have been implemented in the mortgage industry.6 In this context, disclosure has been recognized as an essential element of consumer protection policy in financial services. A salient example of these trends is the Truth in Lending Act (TILA) which was passed by Congress in 1968 that requires that lenders provide consumers with disclosures concerning rates and terms for mortgages, credit cards, and other types of consumer loans.7 A number of other laws also include consumer disclosures as a fundamental component of their provisions, including the Real Estate Settlement Procedures Act, the Consumer Leasing Act, the Electronic Fund Transfer Act, and the Truth in Savings Act.8 Over time, these laws have been amended and new requirements have been added. Indeed, recent federal legislation has required the revision or addition of disclosures through provisions of the Mortgage Disclosure Improvement Act, the Higher Education Opportunity Act, the Helping Families Save Their Homes Act, and the Credit Card Accountability Responsibility and Disclosure.9

Likewise, the U.S. Congress placed further emphasis on the centrality of providing American consumers with timely information concerning their financial transactions by passing the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 that established the independent Consumer Financial Protection Bureau (CFPB). The Dodd-Frank Wall Street Act stipulates that the majority of the disclosure and rulemaking responsibilities for consumer credit and deposit products that previously were the responsibility of the Federal Reserve Board and other federal agencies and other responsibilities for consumer protection in financial services were consolidated under the purview of the CFPB.10

Despite the fact that some type and level of disclosures are routinely provided by most financial services organizations, these initiatives have been important for improving the overall quality... In this regard, Hogarth and Merry emphasize that, “While many financial service firms provide product information in the absence of mandatory disclosure requirements, the presence of these requirements imposes common standards of terminology, presentation, and calculation of relevant figures that can aid consumers in making comparisons between products and providers.”11 This approach is a far cry from the types of disclosure practices that existed in the United States in the early 1960s when disclosures for interest rates on consumer credit products were primarily controlled by state law, and a wide array of standards were used by lenders.12 This problem was addressed by the Truth in Lending Act by creating a common set of national disclosure standards concerning the respective costs of different types of loans. 
The CFPB has reported that students with private loans that are attempting to pay off or reduce their loan amounts are being deceived into paying higher fees with longer repayment terms that inevitably damage their credit ratings.13 The CFPB has expressed increasing concern over the increasing numbers of private student loans and their corresponding default rates. According to the editors of American Banker, “The CFPB -- which has made aggressive steps in 2013 to monitor the private student loan market -- recently said that there are 7 million student loan borrowers who have defaulted in a market with more than $1.2 trillion in outstanding student loan debt.”14 By any measure, $1.2 trillion represents an enormous investment in America’s future, but this future is threatened by the potential default of many students who find themselves unable to repay these loans when they come due.

Despite the fact that the majority of student loans continue to originate with the federal government, students who do assume responsibility for private loans are being placed at a disadvantage compared to federal loans because private loans are typically charged at higher and variable interest rates. In fact, the majority of the recent complaints from student borrowers have related to being manipulated by loan servicers in ways that bilk them out of even more money. For instance, the editors of American Banker point out that, “Many of the 3,800 private student loan complaints that the CFPB reviewed from October 2012 through September were related to payment processing issues, particularly when the borrower tried to pay off the debt early or set up a certain periodic payment structure but incurred a fee to do so.” 15 

The CFPB has also reported that borrowers with more than one student loan have been unable to pay additional amounts on the loan that carries the highest interest rate; rather, their payments have been distributed equally across all loans, thereby extending the loan repayment period.16     In reality, though, these practices are understandable because the longer students require to pay their loans off, the more money loan servicers will generate even though paying off a student loan as early as possible is in the best interest of borrowers. This practice represents a growing concern for policymakers because the provisions of the amended Truth in Lending Act of 2008 prohibit the imposition of penalties for the early repayment of private student loans.17 In other cases, students have been charged extra fees if they tried to modify or reduce their monthly payment arrangements, while in yet other cases their payments have been distributed among different loans in ways that cause them to be charged with other additional fees. In this regard, the editors of American Banker report that, “In certain cases, student loan servicers applied payments in such a way that struggling borrowers did not meet the minimum payment on multiple loans, incurring multiple late fees.”18

In order for students to make an informed judgment concerning their capability of repaying student loans in the future, they must be able to calculate their chances of actually finishing a degree program and they must be able to fully comprehend the terms of their loan repayment. Because student loans represent such a major investment in the future, it is vitally important for borrowers to receive full disclosure concerning the terms of repayment and any potential hidden charges that may be assessed.19 

Unfortunately, the CFPB confirms that loans continue to be made to students with minimal analysis of their potential ability to repay loans, and these loans are made without any cosigners to guarantee repayment. As the editors of American Banker conclude, “Unlike federal loans, there is often no safety net built into these loan programs, such as loan forbearance or modification rights for those who are unable to…