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Student-Loan Collections Could Be Subject to Drastic Overhaul

posted by Nathalie Martin

Bloomberg reports that Congress will consider overhauling debt collection in the $100 billion-a-year U.S. student loan program, replacing it with automatic withdrawals from borrowers’ paychecks tied to their income -- a system similar to those sued in the U.K., New Zealand and Australia. The bill, proposed by Wisconsin Republican Representative Tom Petri, would require employers to withhold payments from wages in the same way they do taxes, capping payments at 15 percent of borrowers’ income after basic living expenses. The bill follows growing concern about the burden of $1 trillion in outstanding student loans, which now exceed credit- card debt. Under the new system, the government would no longer need to hire thugs to collect, and I personally have found these student loan debt collectors to be quite formidable indeed. Never mind that the debt collectors fees can add up to 25 percent to borrowers’ loan balances, leaving defaulted former students even deeper in the hole.  This new process would streamline the confusing process of getting on a reduced payment plan if a borrower is un or under-employed, but would still provide for repayment of the student debt.

According to Bloomberg, last year alone, 5 million borrowers were in default -- generally meaning they had failed to make payments for at least 270 days -- on $67 billion in loans, more than twice the amount in 2003. Through the new system, based on experience in the U.K., 98 percent of borrowers could meet their loan payments through automatic payroll withholding, according to Petri’s office. Last year alone, debt-collection companies -- working directly for the Education Department or for state agencies -- received about $1 billion in commissions, Bloomberg News reported.

This new law would also cap interest owed at 50 percent of a loan’s face value at the time of graduation, giving a break to lower-income borrowers who take longer than the standard 10 years to repay loans. For a student who took out $27,000 in loans, about the national average for a graduate of a four-year program who borrowed, the interest couldn’t exceed $13,500. But here’s the rub.  To offset the cost of capping interest, the bill would eliminate some student-loan subsidies that help low-income families and borrowers. Actually, some of those subsidies are being eliminated no matter what a topic I blogged about last year. 

But these additional proposed subsidy reductions are much more far reaching.  For example, for new loans, low-income borrowers would no longer be excused from accruing interest when they are in college, which worries me. The bill would also eliminate income-based programs that forgive loans entirely after 20 or 25 years -- and, after 10 years, for those who enter public-service careers, such as teaching or law enforcement. This seems like it might put lower income people further behind the 8-ball that they are already. Thoughts?



Putting aside the budget and affordability issues, I think it's worth highlighting that what the legislation proposes to do is functionally a change in the priority of student loan debt. The student loan debt will still rank equal with other general unsecured debt in bankruptcy and will still of course be largely nondischargeable. But its non-bankruptcy priority will be elevated because of automatic payment. Currently there's lots of delinquent student loan debt outside of bankruptcy. This bill would cut down on those delinquencies, but because we're dealing with a zero-sum game, something else will have to give. The federal government's elevation in priority comes at the expense of someone else. I don't know who that someone else might be--credit card lenders? miscellaneous unsecured creditors like dentists' offices? Whether this just means greater losses for that someone else or less availability/higher costs of credit from that someone else is anyone's guess. But it won't be costless. Someone will be internalizing the cost of elevating the government's priority, be it borrowers or nonadjusting creditors. I wonder if we'll see the financial services lobby oppose this bill out of concern that it will make it harder for them to collect outside of bankruptcy because the government will have first dibs on more assets.

Good points Adam. Lets add another that has already caused less payment to unsecured creditors: elimination of cram down so auto lenders get all amounts owed and then some. I wonder how much was gained when the automobiles were returned or seized and the amount actually recovered as a result of either.Pretty soon there may be little benefit of "equality of distribution" to unsecured creditors. Next step in line of costing more: tax payers.

So a student loan promissory note basically becomes a confession of judgment with a 15% garnishment cap that is in addition to the usual 25% cap of regular judgments. Will it be for all loans, not just the government-guaranteed ones? And taking away the income-based programs is something out of Kafka. Idiotic stunts like this just drive more people into the grey market. This stinks like last week's diapers.

Curious if this new bill is just targeted at those who go into default or if it is designed to replace the Pay As You Earn program (Get rid of IBR altogether). You mentioned it would but it seems like there would be a big stir in Washington and ED if that was the case. And there was little talk of that in the couple articles I have seen.

I had never heard of this concept until the last few days. Thanks for the great article and perspective.

I feel as if this bill completely ignores one of the biggest reasons for the increase in student loan debt, and conversely the increase in defaults--rising tuition costs! It may make more sense to work on ways to lower the costs of higher education, rather than eliminate some student-loan subsidies that help low-income families and borrowers, allow interest to accrue while students are in school and eliminate income-based programs that forgive loans. We are rapidly putting people in the position to have to choose between debt and education--a catch 22 situation if I ever heard of one.

Trying to hold students accountable for rising tuition costs, which is what these harsh bankruptcy laws are attempting to do (through the power of the free market!), is absurd.

And why does everyone keep talking about "average" debt? How many students actually graduate with "average" debt? There are probably more students who graduate with mountainous debt and more students who graduate with little to no debt than there are students who graduate with the mean debt.

And it's a really perverse system, because the best students, and therefore the students most likely to be capable of repaying loans, are the least likely to take the loans because they get scholarships. The education of the most capable citizens is being subsidized by those more likely to struggle. This makes it even more difficult for those "average" students to escape their loans.

Law professors, as members of faculty at schools where the tuition explosion has been most pronounced, you and your colleagues all have a special role to play in this catastrophe.

I do not believe there is one universal remedy to cure the student loan debt problem. Possible considerations that are not one that will fix all but potentially a few mixed into one can begin repairing a broken system:
-For profit and non profit loans are different and each should have an individual remedy. The BAPCP made the mistake to not discharge for profit loans so that allowed lending quality to be non-existent.
-Allowing the bankruptcy code to discharge all student loan debt is wrong because that will only open up the loan market to expand far worse than it is today and place an undue burden on tax payers.
-Academic institutions should be accountable to controlling expenses and tied into the amounts to be granted for student loans. Should these same instituions also be required to repay all or a portion of student loans that are delinquent?
-While the payroll deduction mandate to repay loans may appear good, the same problems are going to arise as we have seen from the means test in bankruptcy. For example who is going to enforce or keep track when employment changes occur that could either increase or decrease deductions?
-Develop credit standards that are realistic because the existing platforms in the market place have not shown improvement in decreasing delinquencies because one platform model doesn't fit for or not for profit educational standards plus do not take into consideration actual geographic residency of students.
-Require finacial education courses before lending to students, and if loans are cosigned by third parties the same requirement applies. Do not allow financial education courses similar to those conducted in bankruptcy and to establish a monitoring system of these courses to better evaluate content.

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