December 6, 2012

Student-Loan Collection Targeted for Overhaul in Congress

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 used in the U.K.

Legislation that Wisconsin Republican Representative Tom Petri plans to introduce as soon as this week would require employers to withhold payments from wages in the same way they do taxes. Payments would be capped at 15 percent of borrowers’ income after basic living expenses.
Congressman Tom Petri of Wisconsin

U.S. Representative Tom Petri's bill would require employers to withhold payments directly from borrowers’ paychecks in the same way they do taxes. Photographer: Troy Freund/Petri's Office via Bloomberg
Enlarge image U.S. President Barack Obama

U.S. President Barack Obama speaks about student-loan interest rates at the University of Nevada. Photographer: Isaac Brekken/Getty Images

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 private debt-collection companies and charge fees that add as much as 25 percent to borrowers’ loan balances, leaving defaulted former students even deeper in the hole.

“This doesn’t mean leaving taxpayers on the hook if a student borrows too much -- everyone would still pay back what they borrow under this system,” Petri said in an e-mail. “It does mean providing much stronger protections against the kind of financial ruin that is all too prevalent in our current system.”

The plan would resemble those in the U.K., Australia and New Zealand. Since the money would be withdrawn automatically and tied to income, borrowers would no longer have to negotiate with collectors and loan-servicing companies, which often offer a confusing array of deferral and forbearance options after a job loss or illness. The Education Department would manage the withdrawals, with help from the Internal Revenue Service.
Election Issue

In the U.S., borrowers currently must ask to be enrolled in income-based repayment programs and many don’t because they don’t know about them or collections companies don’t tell them.

In the election campaign, President Barack Obama touted the income-based program as a way to make it easier for students to pay back their loans, while unsuccessful challenger Mitt Romney said it encourages students to take on more debt.

Last year, 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.

The Education Department already has the power, without a court order, to seize a part of wages, tax refunds and Social Security payments to collect on student loans. There is no statute of limitation.
Collection Complaints

The bill would all but eliminate the government’s need to hire private debt-collection companies, which have drawn criticism for insisting on stiff payments even when borrowers are eligible for income-based repayment. Those companies’ tactics and commissions were the subject of a Bloomberg News article in March.

Last year, debt-collection companies -- working directly for the Education Department or for state agencies -- received about $1 billion in commissions, Bloomberg News reported. They included Pioneer Credit Recovery, a unit of Newark, Delaware- based SLM Corp. (SLM), the largest U.S. student-loan company known as Sallie Mae.

Such collections, which can follow borrowers into retirement, “can ruin people’ lives,” said Justin Draeger, president of the National Association of Student Financial Aid Administrators, a Washington-based nonprofit group. “The sad part is that borrowers already have an income-based repayment option but they aren’t taking advantage of it.”

Patricia Nash Christel, a spokeswoman for Sallie Mae, declined to comment.
Interest Cap

The legislation would tie the interest charged to Treasury market rates. Currently, students in the most popular program pay as much as 6.8 percent.

In another boon to borrowers, the plan would 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.

Student loans, which can rarely be canceled through bankruptcy, can balloon to several times their original size, after adding interest and collection fees.

Along with facing private debt collectors, students may also be sued by the U.S. Justice Department, which hires private attorneys to pursue debtors who default on decades-old loans, Bloomberg News reported in July.
Loan Subsidies

To offset the cost of capping interest, the bill would eliminate some student-loan subsidies that help low-income families and borrowers.

Low-income borrowers would no longer be excused from accruing interest when they are in college. 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. The new system would apply only to new loans.

While Petri’s bill makes sense, the elimination of the low- income subsidies and forgiveness could face opposition from Democrats, said Sandy Baum, a senior fellow at the George Washington University School of Education. Republicans may be concerned that taxpayers won’t be repaid if more borrowers join the income-based program, she said.

With a few weeks left in the current congressional session, the bill will likely be considered early next year, according to Petri’s office.

www.bloomberg.com

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