Do the New Student Loan Servicing Rules Go Far Enough?

Last month, the Department of Education announced a new set of directives to target systemic problems that have plagued federal loan servicing for years. Will the new recommendations help, or will they end up being just another stack of papers piled on to an already labyrinthine federal loan bureaucracy?

How Borrowers Are Shortchanged

One of the main criticisms of the student loan servicers hired by the government is that they are prioritizing profits over helping federal loan borrowers. This isn’t entirely unexpected, since federal loan servicers are private for-profit companies. With a steady drumbeat of negative press surrounding federal loan servicing, there have even been calls for the entire federal loan servicing process to be run by the government.

Still, instead of scrapping the private contractor loan servicing system and replacing it with another government department, the Department of Education is making a serious effort to align the private loan servicing companies’ incentives with its vision for a streamlined process. The fact that this directive is a joint effort by the Department of Education, the Consumer Financial Protection Bureau, and the Treasury Department shows that the government is serious about reforming student loan servicing.

The newly released policies aim to address some of the biggest functional problems with federal loan servicing, such as borrowers not being fully informed about options for different payment plans, or how to use Direct Consolidation to make Federal Family Education Loans eligible for other programs like Public Service Loan Forgiveness. How they do this is, first and foremost, by changing the way loan servicers are compensated for helping students in danger of default stay current on their payments.

From a business standpoint, it doesn’t make sense for loan servicers to spend more time only to receive the same payment. Since loan servicers are for-profit companies, it is up to the Department of Education to provide them with incentives and contracts that align with its overall goals of reduced defaults and better communication with borrowers. When a loan servicer is compensated with the same amount whether they place someone in a forbearance (a short-term solution) versus an income-related payment plan (a long-term solution), they will inevitably do what is the most economically feasible — using the option that requires the least amount of time. This is just one example of how a fixed-rate financial incentive system shortchanges borrowers who need effective student loan counseling from their loan servicers.

Going a Step Further

The Department of Education implemented a policy in 2014 to reduce loan servicers recommending forbearance as a first-choice option to struggling borrowers. This was in favor of longer-term solutions like income-driven payment plans. These new policies go a step further to provide financial incentives for loan servicers to keep borrowers current by changing from a fixed-rate compensation system to one that rewards loan servicers for taking additional time and effort to provide specialized assistance to borrowers who are at the highest risk of default.

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For loan servicers that have drawn more regulatory scrutiny and complaints than others, there needs to be more monitoring and accountability, which is emphasized in the new policy directives. By holding loan servicers accountable and not blindly renewing their servicing contracts despite some performing much worse than others, the Department of Education creates another financial incentive for loan servicers to improve. If they don’t, their bottom line could suffer as a result of fewer loans being allocated to them.

Streamlining the Process

By having loan servicers use Department of Education-branded letterhead for all communications, borrowers won’t be as confused as when they receive letters from their servicer — especially if they have switched servicers or aren’t aware who their servicer is after leaving school and beginning repayment. The Department of Education also wants to reduce any unnecessary loan transfers (those not initiated by the borrower). Being unable to determine which loans are private and which are federal is one of the most common issues I hear about from student loan borrowers. Creating uniformity with letterhead and branding for federal loans regardless of which company is servicing them should help solve that problem.

Establishing a single online portal will also make it easier since borrowers now can log into Studentloans.gov and separate loan servicer websites as a federal loan management portal. It makes sense to just have one web portal to eliminate the overlap and any resulting confusion.

Improving overall customer service metrics such as hold time and response time, as well as implementing a guideline for processing any income-related payment plan application in 10 days or less, are common sense ideas that are aimed at increasing federal loan servicing efficiency and borrower satisfaction.

Another goal is to make sure loan servicers are reaching out to borrowers who have made mistakes on their income-related payment plan applications, or who have submitted incomplete applications. This is important because the newly redesigned income-related payment plan paper applications have been criticized for being harder to complete than the previous versions.

There is increased emphasis on recertification notifications for borrowers on income-related payment plans that require yearly reverification of income and tax filing status, so that borrowers don’t fall off the plan and end up back on a payment plan they can’t afford, which can lead to default.

Another part of the initiative is to ensure that borrowers aren’t being punished for processing delays that are not their fault, and that they will remain on their income-related payment plan as long as they get the recertification in by the deadline — and if they miss the deadline, that they will receive guidance from their loan servicer for getting back on track.

Some other directives in the new policies are also a continuation of previous attempts to fix loan servicing problems. Disabled borrowers who may be eligible for Total and Permanent Disability Discharge were having their SSI payments offset due to defaulted federal loans. Part of the servicing recommendations are aimed at continuing to improve that. The Department of Education has been working closely with the Social Security Administration to do a “data match” of borrowers who are on disability and then trying to proactively reach out to them to inform them about the possibility of a loan discharge. Earlier this year, the Department of Education identified hundreds of thousands of borrowers who may be eligible for TPD discharge by coordinating with the SSA to identify them.

Addressing Other Problems

All of these new policies combined could also go a long way toward reducing the need for outside assistance that “student debt relief” companies try, and often fail, to provide. These companies charge hundreds or even thousands of dollars to prepare applications for free programs like Direct Consolidation and IBR — often without disclosing that the borrower could have applied for free on their own. Even worse, many “student debt relief” companies try to use official-sounding names so that borrowers confuse them with legitimate federal loan servicers.

By addressing the core structural problem with loan servicing — financial incentives — and moving away from a fixed-rate compensation system regardless of servicing outcome, the Department of Education may be able to reform loan servicing with the ultimate goal of reducing defaults and improving the overall experience for student loan borrowers.

Whatever the outcome, one thing that is clear from this policy directive is that the Department of Education has identified some of the main problems with loan servicing after intensive study, research, and coordination with other federal agencies.

If serious efforts are then made by the loan servicers to put these policies in place, there’s a real chance that borrowers will have a better experience repaying their loans, and that fewer borrowers will experience the devastating financial impact of student loan default.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

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