Are Student Loan Servicers the Bad Guys or the Fall Guys?

There is plenty of blame to go around for the student-loan-debt debacle, and the Consumer Financial Protection Bureau along with the Departments of Education and Treasury are particularly interested in the role that the loan-servicing industry has played.

In its recent report on student loan payment performance, the CFPB analyzed some 30,000 comments it received from borrowers, financial services providers, law enforcement officials, banking regulators, policy experts and organizations that represent students, lenders, servicing companies and, of course, the schools.

The crux of the matter, according to the bureau, is that “there are no consistent, market-wide federal standards for student loan servicing and servicers generally have discretion to determine policies related to many aspects of servicing operations.” Hence the myriad complaints about incomplete or inaccurate information, payment processing issues and other problems—which vary in degree among loan-servicing companies—that contribute to the extraordinarily high level of payment delinquency and loan default that is emblematic of the second largest form of consumer-financing in the U.S.

The bureau’s report culminates in a series of reform recommendations to policymakers and a jointly issued statement of principles on student-loan servicing by the bureau and its governmental department collaborators: Servicers are to be consistent in their approach to the tasks at hand; information and recommendations are to be accurate and actionable; all servicers (for-profit and not-for-profit alike) will be held accountable for their missteps, and higher-quality performance-related data is to be made freely available.

The thing that most bothers me about this and earlier reports on the matter of loan-servicing malfeasance is the notion that servicers are exclusively at fault.

Don’t get me wrong. From all that I’ve read and heard firsthand from debtors who are actively dealing with many of the issues cited in the CFPB report, it’s hard not to conclude that even if they aren’t deliberately deceitful, some of these companies are at the very least hopelessly incompetent. But what about those who also stand to benefit from these injurious practices?

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I’m talking about the noteholders — governmental and private sector alike, including investors to whom the loans are later sold — that hire these companies in the first place.

Let’s start by separating the policies and protocols that deal with the servicers’ internal operations (such as those that govern levels of approval and the order in which certain tasks are to be performed) from those that are contract-specific (such as policies and/or practices that are calculatingly designed to maximize financial rewards).

In the absence of those regulations that the bureau and others lament have yet to be enacted, loan servicers should at the very least be held accountable for improper actions that exclusively benefit the subcontractor, and jointly held responsible with the noteholders for those that benefit both.

That’s the least we can do. My preference, though, would be to hold both parties equally accountable in all things and let them sort that out in accordance with the binding terms of their contracts. After all, that’s why God invented indemnification clauses: Each party assures and holds harmless the other for the negative consequences of their individual actions. Doing so will also inspire each to more thoroughly underwrite and thoughtfully contemplate the qualifications and motivations of the other.

While we’re at it, let’s also align consumer loans that are second in size to residential mortgages with that form of financing by granting protections to student-loan borrowers that are consistent with those of homebuyers.

Specifically, mandatory arbitration should be prohibited (as the CFPB is contemplating, at least for class actions) so consumers may regain their constitutional right to trial by jury, among other things (including the right to file class-action suits). So too should we reverse the exclusions that federal student loans currently enjoy under the Truth in Lending Act, such as for late-payment-fee pyramiding, which can occur when a consumer’s loan payment is not first credited against unpaid principal and interest.

In fact, why not establish a universal protocol for the application of all remitted payments so principal and interest are credited first, outstanding fees (such as for late charges and bounced checks) second, and any remaining value is then automatically applied against principal?

As it now stands, unless the borrower formally instructs otherwise, the servicer may elect to credit the additional payment amount against the borrower’s future installments, which is akin to paying interest that has yet to be earned by the lender.

And, while we’re on the subject of universally applied protocols, let’s also address the matter of co-signed loans, which is more of an issue in the private sector than it is with Federal Direct and Federal Family Education Loan programs. Requiring a second signatory at the outset of the agreement is reasonable: Applications from young borrowers with limited earnings and scant credit histories typically require the support of those with more to offer in exchange for what is, in effect, an uncollateralized borrowing.

But is it fair to keep that co-borrower on the hook after the primary borrower has established his or her credit creds? I think not, especially when one considers the virtual inability to discharge education-related debts in bankruptcy.

A more equitable approach would be to mandate annual reviews to commence after two or three years of reasonably prompt payment history, for the purpose of releasing the co-signer from his or her obligation. I emphasize the word reasonably because in this context, it’s unreasonable to expect that first-time borrowers won’t miss a due date or two as they acclimate to post-college life.

Look, whether or not you agree with the manner in which the business of higher education is conducted — escalating tuition prices, the easy-credit policies that helped bring us to this point or the apparent unwillingness of our elected officials to address this problem once and for all — let’s not make it even harder for borrowers to do what the majority of them intend: to honor their obligations.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.