Student Lending Probes and Lawsuits

While rising college loan balances remain a cause of concern, there is a bit of good news. The number of students using private loans from commercial financial institutions has declined while the number of those opting for federal loans has risen.

A study conducted for the National Center for Education Statistics (NCES) found that private student loans fell by 50% from 2008 to 2012.

The distinction is an important one. Private loans are different from federal loans because they're made by banks, credit unions, and other commercial institutions and are not federally guaranteed.

They tend to be like other commercial loans, with terms usually based on market conditions and the borrower's credit history.

Just another consumer loan

Like other consumer loans, the lenders set the terms and conditions of the loan, usually basing them on the market and the borrower’s credit history. Federal loans generally have terms that are more advantageous to the borrower.

According to the research, private loans only accounted for 5% of undergraduates in 2004 but surged to 14% by 2008. It then dropped to 6% in 2012.

At the same time, the percentage of students taking out federal loans through the Stafford program increased from 35% to 40% over the same period.

It's probably no surprise that private loans dropped sharply after 2008, since the credit crisis hit with full force late that year. Lending standards tightened and banks and financial institutions made fewer loans for any purpose.

Better off with federal loans

“Generally private loans have stricter terms and harsher penalties for non-payment than federal loans do,” said Jennie Woo, Ed.D., lead author and a senior education researcher at RTI, which conducted the study. “Students who are eligible for federal loans are better off getting them instead.”

The study focuses on one possible reason so many consumers are struggling with college loan debt. The proportion of borrowers who took out private loans was highest at private for-profit schools, especially in 2008. These schools tend to be among the most expensive, and some – like Corinthian and ITT – have closed their doors, stranding students with the highest loan balances and the least favorable terms.

The Consumer Financial Protection Bureau (CFPB) advises students to always choose a federal loan if possible. It points out that the interest rate on a federal loan is fixed, while the rate on private loans often fluctuates.

The epidemic of student debt has led to any number of bogus debt relief schemes. The Federal Trade Commission (FTC) and the state of Florida last week took action against two allegedly phony student debt relief schemes, and defendants in a similar FTC action filed earlier this year have agreed to get into another line of work.

“The FTC is not going to stand on the sidelines when it uncovers evidence of fraudsters targeting students,” said Jessica Rich, Director of the FTC’s Bureau of Consumer Protection. “Consumers should be wary of any company that claims it can eliminate or greatly reduce debt, especially if they ask for money in advance.”

Federal and state agencies are powerless, however, to combat such government-sanctioned frauds as the U.S. Education Department's TEACH Grant program, which recruits young teachers to take assignments in troubled schools, then routinely converts their grants to loans, claiming administrative errors.

Teachers stuck paying wrongful debts call the program "legalized theft." Federal bureaucrats and elected officials know about the problem but have done nothing. 

The private-enterprise schemes are more easily dealt with.

"These latest joint actions will help protect Floridians, as well as many across the country, from these companies’ unscrupulous debt relief operations and ensure that those responsible will be held accountable,” Florida Attorney General Pam Bondi said.

Consumer Assistance Project

The FTC and Florida charged that the Consumer Assistance Project lured borrowers with promises such as “GET RID OF YOUR DEBT TODAY!” and then charged illegal up-front fees -- typically $250, plus monthly fees of up to $303 -- for as long as 36 months.

According to the complaint, the defendants pretend to evaluate these consumers for eligibility and then tell them they qualify for government student loan forgiveness programs that will reduce their debt by at least 50 to 70 percent. In reality, the FTC alleges, consumers are not likely to meet the strict requirements of these loan forgiveness programs.

Student Aid Center

In the second case, the Student Aid Center Inc., and its owners allegedly enticed people with promises such as “Get Your Student Loans Forgiven Now!” and “$17,500 in Up Front Forgiveness?”

Student Aid Center also told consumers they were “approved” or “pre-approved” for loan forgiveness or lower monthly payments, which they could get by paying up-front monthly fees, typically $199 or more for five months.

The defendants’ websites, including studentloanforgiveness.org, included more false claims, and their telemarketers deceived people with false promises of a 100 percent money-back guarantee, the complaint alleges.

Attorneys general in Washington and the District of Columbia have also filed actions against Student Aid Center.

Good EBusiness

In a separate case, the operators of another student debt relief scheme have agreed to a settlement with the FTC that will permanently ban them from the debt relief business.

The FTC alleged that Tobias West and his wife, Komal West, the owners of Good EBusiness, Select Student Loan Help LLC, and Select Document Preparation Inc., charged consumers up-front fees of $500 to $800 based on phony claims that they could renegotiate, settle, or alter payment terms on student loan debt.

In addition, the FTC charged that two of the defendants deceptively marketed home loan and student modification services under the name “AAP Firm,” illegally charging advance fees ranging from $1,000 to $5,000.

At last estimate, about 43 million Americans – mostly young – owed student loans totaling more than $1.3 trillion.

Paying back that money has strapped many consumers, just at the time they are forming households and should be making key purchases, such as homes and cars.

What is important for these borrowers to understand is that they have options when it comes to paying back the money. There is no one-size-fits-all payment plan.

Payback Playbook

To help student loan borrowers understand their range of options, the Consumer Financial Protection Bureau (CFPB) has assembled a Student Loan Payback Playbook, a set of disclosures that can guide borrowers to finding a payment plan that minimizes financial stress.

CFPB Director Richard Cordray says millions of borrowers are falling behind on their student loan debts, probably unaware that federal law gives them the right to an affordable payment. Working with Illinois Attorney General Lisa Madigan and others, Cordray says the CFPB developed a way to make sure student loan servicers provide personalized information to each borrower.

“This will help these borrowers take action, stay on track, and steer clear of financial distress,” Cordray said.

The Department of Education has several repayment plans that afford student loan borrowers with tailor payments that work within their monthly budgets. For example, one plan lets borrowers specify their own payments, based on income.

High default rates

Despite the availability of these repayment options, many borrowers continue to struggle. The CFPB says 25% of student loan borrowers are either behind on their payments or are in default.

The agency believes that part of the problem is a lack of awareness among borrowers that they have options. A recent Government Accountability Office (GAO) study found that 70% of direct federal loan borrowers in default had incomes low enough to qualify for reduced monthly payments.

The Playbook evolved from work begun last year to reform student loan servicing practices. In particular, the CFPB would like to enlist servicers in the effort to help borrowers understand their options, since there is already an established relationship.

The CFPB has taken regulatory action against some companies for alleged illegal student loan servicing practices.

This isn't the CFPB's first effort to inform borrowers of their rights. Last year the agency announced its Revised Pay As You Earn (REPAYE) plan to allow five million more direct loan borrowers to cap their monthly student loan payment amount at 10% of monthly discretionary income.

The REPAYE Plan was an upgrade of the original Pay As You Earn Plan, while extending its protections to all student borrowers with direct loans.

Consumers with student loan debt may have a new repayment option under a new Department of Education regulation that recently took effect.

The Revised Pay As You Earn (REPAYE) plan will allow 5 million more direct loan borrowers to cap their monthly student loan payment amount at 10% of monthly discretionary income, without regard to when the borrower first obtained the loans.

As the name implies, the REPAYE Plan improves upon the original Pay As You Earn Plan, while extending its protections to all student borrowers with direct loans.

Besides the monthly payment cap, REPAYE will wipe the ledger clean after 20 years for those who borrowed only for undergraduate study and 25 years for those who borrowed for graduate study. It also provides new protections against ballooning loan balances for borrowers whose income-driven payments can't keep up with accruing interest.

But before you rush to sign up, consider this.

Might not be a perfect fit

“Just because a new program is announced, it doesn’t mean that it is going to be a perfect fit for every borrower,” said Bruce McClary, spokesman for the National Foundation for Credit Counseling (NFCC). “It takes a clear understanding of the benefits available through each option and how those are applicable to a person’s unique circumstances.”

So, what does this new program mean, exactly, in dollars and “sense?” McClary says it could be substantial for consumers with huge student loan balances, struggling to make ends meet.

Discretionary income for this purpose is calculated as the difference between adjusted gross income, taken from the tax return, and 150% of the current poverty line. For this year, that payment would be 10% of what is earned over $17,655 divided by 12 months.

Here's an example; a person earning $30,000 a year would see payments capped at a budget-friendly level of about $102.88 a month.

Why now?

Policymakers are concerned that consumers struggling with student loan debt, many of whom are Millennials, are so financially stressed they can't afford other things – in particular, they are having a difficult time buying houses because they can't save for the down payment. This, in turn, is a strong drag on the economy.

But what really has policymakers worried is the upward trend in student loan defaults. Those defaults can have a long-lasting impact on a borrower’s financial well-being. A record of late or missed loan payments impacts a borrower’s credit history by making any new loan requests -- for cars or homes -- more expensive or just extremely difficult to qualify for.

There is a downside.

McClary says borrowers need to proceed with caution. For some, this new payment option might mean the monthly payment doesn't cover both interest and principal payments, which means the balance could keep growing.

That makes it harder to get other types of loans, from credit cards to mortgages, because the borrower’s credit capacity is tapped out.

Another risk? McClary says the lower monthly payment under REPAYE could lead the borrower to pay substantially more over the life of the loan when compared to a Standard Repayment plan.