Why Federal Student Loans Need New Debt Collection Protections

Democrats have sharply criticized President Trump for making aggressive use of his executive power, and of course the president has repeatedly tested the limits of his constitutional powers. Yet in one area they are outdoing the president, urging Joe Biden, if elected, to write off up to $ 50,000 in federal student loan debt for millions of borrowers.

General debt cancellation would be a very aggressive use of presidential power under the Higher Education Act, where the power to “give up or release” debt appears to be focused on distressed borrowers. But given the weight of $ 1.5 trillion in federal student debt on our economy, this may well be justified. At the very least, this executive authority should be used to relieve distressed borrowers by better aligning government debt practices with those of regulated bank lenders.

When making unsecured consumer loans, banks are required to assess whether a borrower will be able to repay the principal and interest on their loan once it is due, and also to provide information. standardized on loan costs and repayment conditions. If a loan goes unpaid, government supervisors typically require banks to write off loans once they are 120 days past due. While banks may continue to seek collections after debt is written off, these collection efforts are subject to state limitation periods (SOL) and the Fair Debt Collection Practices Act. Domestic lenders often choose the most conservative state SOL by default and stop collection efforts after three years. Private lenders are also subject to various state and federal limitations on “negative amortization,” the practice of adding overdue charges and interest payments to amounts owed. This can lead to distressed borrowers having debt obligations that increase in multiples of the amount they originally borrowed and are frowned upon by bank examiners.

In contrast, the government makes no effort to determine whether student loans are affordable, and borrowers do not receive standardized information on loan terms and estimated repayments. In addition, government accounting does not require the write-off of seriously delinquent student loans. This may be because there is no federal prescription on student loan collection and the government may resort to unauthorized collection tactics in the private sector, including debt garnishment. social security and other government benefits. Consumer protections against abusive debt collection tactics do not apply to government, nor do state statutes of limitations. The government regularly garnishes the salaries of defaulting borrowers by charging 20% ​​per payment. It also uses repayment plans that set minimum payments lower than required to cover interest, which dramatically increases borrowers’ total obligations over time due to negative amortization. In some cases, the government even charges interest on a borrower’s unpaid interest. Finally, student debt is generally not dischargeable in bankruptcy, which means the government can and will follow a defaulting borrower to their deathbed.

In order to better align the practice of the federal government with that of private lenders, there should be a time limit on debt collection for defaulting student borrowers. Three years would be compatible with the most conservative SOL condition. At the most, the limit should be five years. Research shows that collection efforts after this point are unlikely to be successful, costing taxpayers unnecessary administrative expenses and creating stress for borrowers.

Default exit rates calculated by the American Enterprise Institute.

To deal with the pernicious impact of negative amortization, a student borrower’s total repayment obligation (including fees) should be capped at a reasonable multiple of the amount they originally borrowed, maybe 1.5 times for undergraduates, with higher multiples for graduate and professional students who borrow more but also have higher incomes. Canceling the debt of those who have been in default for more than 3 to 5 years, as well as debt that exceeds 1.5 times the amount originally borrowed would eliminate the worst of government debt collection abuse.

Such measures would be particularly beneficial for low-income borrowers of color, including African-American borrowers. Research shows that black borrowers are overrepresented among borrowers who default over several years and are also more likely to have growing loan balances due to negative amortization. Those who fail to complete their education end up with high debt and no diploma.

Progress on Student Debt Repayment by Race.  (JPMorgan Chase Institute)

Progress on Student Debt Repayment by Race. (JPMorgan Chase Institute)

Black borrowers are also more likely to have been targeted by a for-profit college degree mill. And they are the hardest hit during major economic crises, including this pandemic.

Bank examiners have a name for banks that try to put troubled borrowers into “payback” plans in the hope that one day they will be able to pay off their debts: “stretch and pretend”.

Not only does such a practice obscure the true financial soundness of a bank, it is also bad for the economy. Banks tend to bad debt-laden balance sheets, instead of writing off losses and moving on. More importantly, the over-indebtedness caused by extension and simulation inhibits consumer spending because borrowers are never quite released from their past obligations. The ability to secure a fresh start is the reason we have a consumer bankruptcy process, but this process is denied to student borrowers.

During the Great Financial Crisis, resistance to the cancellation of government guaranteed mortgage debt – also non-dischargeable in bankruptcy – weighed on our economy for a prolonged period. With the government’s stubborn reluctance to write off student debt for even the most distressed borrowers, we are repeating the same mistake. Much remains to be done to reform the student loan system. I have long maintained that the government should give up debt in favor of revenue sharing arrangements. But at a minimum, we should force the government to meet the same standards that it expects from private lenders.

We do not allow banks to extend and pretend that loan obligations are clearly unaffordable for borrowers. We should at least ask the same of our government.

Sheila bair is the former chairman of the FDIC and has held leadership positions in the Republican and Democratic administrations. She is currently a board member or advisor to several companies and a founding board member of the Volcker Alliance, a non-profit organization created to restore trust in government.

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