10 Ways to Fix Student Loans in 2014

If you thought the politics behind the student loan pricing debate were contemptible, just wait until Congress takes up the reauthorization of the Higher Education Act this year.

For nearly a half century, the HEA has been responsible for a variety of financial assistance programs for students and educational institutions. Title IV is arguably the best known facet of the act. It governs Pell and Supplemental Education Opportunity grants, the Federal Work Study program, Perkins Loans, Direct Subsidized and Unsubsidized Stafford Loans and Direct PLUS Loans. (The FFEL program was discontinued in 2010.)

Although much of what promises to be yet another ideological altercation over funding levels and the government’s role in higher education, lawmakers hopefully will remember the nearly $1.2 trillion of student loan debt that’s choking our kids and holding back the economic recovery.

Here are 10 actions that Congress can take to address the student loan debt debacle it helped to create.

Broaden the federal relief programs to include all loans, regardless of origination channel (government and private), effective date, payment status (current versus past-due) or if an accommodation was previously granted. Half-way is no way to handle a crisis of this magnitude.

Restructure the distressed loans so that interest rates or no higher than the prevailing Direct Loan rate and the aggregate monthly payments don’t exceed 10% of the preceding year’s before-tax income divided by 12. Loan durations will need to be extended to accommodate the change, but that shouldn’t be open-ended: 20 years of debt payments for a 20-year-old’s education is long enough. Frankly, these loans should have been structured on that basis in the first place, given the huge amount of dollars that are involved.

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Make a tax exemption for any debt forgiveness that may result from the 20-year term limit, just as the Mortgage Forgiveness Debt Relief Act of 2007 did for homeowners whose unaffordable loans were modified by the banks.

Direct the credit bureaus to expunge pre-relief student loan payment histories so borrowers are not penalized for difficulties that were inadequately addressed in the past.

Direct the regulators to relax the rules governing troubled debt restructurings so banks are encouraged to revise payment terms for distressed borrowers without concern (or excuse) for the negative financial ramifications that typically go along with this activity.

Repeal the amendment to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 that granted private lenders the same protections against discharge that the government enjoys, without also compelling them to offer borrowers equally favorable rates and terms. Doing so will provide the proper incentive for lenders to negotiate in good faith on their unsecured loans.

Ensure that all student loan-servicing and collections companies comply with all consumer protection laws. Education borrowers deserve the same protections as any other class of consumer-borrower, especially when it comes to the Fair Credit Reporting and Fair Debt Collection Practices acts.

Establish a universal standard for the processing of student loan remittances that records borrower-payments on the dates they are received and applies that cash in this order: first to interest, second to principal and third to any unpaid fees (such as for a prior late payment). And should the value of the remitted payment exceed the amount that’s currently due, the fourth step in the cash-application process should be to credit that excess against the remaining loan balance, unless the borrower explicitly directs the servicer to issue a refund or offset a future loan payment. Servicers should be held financially responsible for the misapplication of payments to the detriment of the borrowers.

Establish minimum acceptable levels of loan-servicing performance that measure payment delinquencies and defaults, as well as customer service-response turnaround time. Loans that have been granted forbearance or deferment should be counted as delinquent and all past-due payments should only be measured against loans that are in repayment mode. That way, servicers with relatively high values of deferred loans (for borrowers still in school) are not favored and the data is more revealing. Forbearances and deferments should also be more closely monitored and benchmarked as a group so that servicers and lenders that delay loan restructurings in favor of temporary solutions that cost borrowers more (because of the capitalized interest) are held accountable.

Prohibit the transfer of chronically delinquent or defaulted loans to affiliated collections companies, or to entities with which the servicers enjoy an economic relationship (such as in the form of referral commissions). That way, no one company may doubly benefit from the servicing of any one loan.

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Clearly, these actions will amount to an expansion of the government’s role in this regard. After all, we’re talking about $400 billion to $500 billion that could make its way to the Department of Education’s balance sheet (approximately $150 billion of private student loan debt plus a portion of the approximately $300 billion of privately-owned, government-guaranteed FFEL loans that have not already been restructured). But that doesn’t mean the taxpayers should be left holding the bag. There are two actions the government can take to limit their (and the public’s) exposure.

Establish a proprietary securitization program. Why let others do for you what you can do for yourself more economically? FFEL loans are routinely securitized by financial intermediaries (such as Sallie Mae) that skim profits from the deals they put together. What’s more, the design of these transactions is intended to benefit issuers, servicers and investors, without due consideration for the needs of financially distressed borrowers—which is one of the reasons why so few of these loans have been restructured). If the government takes a principal role in the securitization of loans for which it is directly (Federal Direct) and contingently (FFEL) responsible, investors will stand to benefit from the elimination of an added layer of cost. Borrowers will also benefit because the transactions will provide for the loan-restructurings that may become necessary at some later date.

Establish a student-loan loss pool. Moving all these loans into government-sponsored relief programs will result in increased losses. That’s why it’s time for the entities that benefitted from the DOE’s largesse to give back some of what it received. An individual school’s assessment could be determined by applying its cohort default rate against the value the institution received in federally-sponsored grants and loans during the same period. A private lender’s assessment could be based upon the difference between the rates it and the government charged during the same period, as an offset to the value of the loans that move from the private lender’s books to the government’s.

No doubt these actions would inspire significant changes in behavior.

Lenders would become more circumspect in their lending practices — something that should have happened long ago. Or, as one student-borrower recently said to me: “I was an 18-year-old freshman who couldn’t get approved for more than a $750 credit card line. Yet, the student loan company gave me $25,000 to spend. On my own. I would have been better off had they turned me down.”

The schools should also plan for a more austere future.

Today’s consumers are realizing that they can no longer afford to pay for the administrative redundancies that exist between schools in close geographical proximity, nor the intercollegiate infrastructural warfare that takes the form of bigger and more luxurious sports centers and dormitories, or the capital that’s literally buried in these assets when it can be put to better use developing and delivering enhanced educational content.

The HEA has helped America to become a better educated country. Unfortunately, it also made it possible for many schools and financial institutions to help themselves at taxpayer expense. Perhaps the act doesn’t need to change as much as the manner in which it’s administered.

(Editor’s note: If you’ve had difficulties paying your student loans in the past, it’s important to understand how your payment history affects your credit. You can get a grasp on your credit standing by checking your credit reports, which you can do for free once a year through AnnualCreditReport.com, as well as by monitoring your credit score, which you can do for free using a tool like Credit.com’s Credit Report Card.)

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