This past October, the Consumer Financial Protection Bureau issued a report predicting that approximately one third of borrowers who had rehabilitated their federal student loans would default again over the next two years. The statistic is startling, especially if you consider the substantial effort borrowers must exert to complete the rehabilitation program to begin with and the significant consequences of defaulting again.
The Student Loan Ranger agrees with the bureau’s estimate — in fact, it may even be a little low.
[How to use rehabilitation to recover from student loan default.]
The real root of the problem, though, is not just a flawed transition between the successful conclusion of the rehabilitation program and the borrower’s new repayment plan, as detailed in the bureau’s report. Unfortunately, the Student Loan Ranger thinks t he very regulations that dictate rehabilitation may be setting borrowers up to fail.
Under rehabilitation , defaulted borrowers make nine consecutive, on-time payments in an amount agreed to by both the borrower and the loan holder, which at this point is either a collection agency or a guaranty agency, both of whom are working on behalf of the federal government.
Once the borrower has made those payments, the loan is back in good standing and is transferred back to a loan servicer. It is again eligible for things like income-driven repayment options, deferments and loan forgiveness under the Public Service Loan Forgiveness program.
[Know when it’s OK to postpone your student loan payment.]
Two of the most beneficial aspects of rehabilitation are the removal of the default line from the borrower’s credit report and the reduction of collection costs to 16 percent — from as high as 24 percent for straight collections. In fact, if you start the rehabilitation program within 60 days of your initial default, there won’t be any collection costs at all.
Under rules that came into effect last year, the borrower has two options for payment. The first requires the borrower to submit proof of income, at which point the loan holder determines a payment equal to 15 percent of the borrower’s adjusted gross income minus an amount equal to 150 percent of the poverty line for the borrower’s family size. This is the exact calculation that is used under the income – based repayment plan that most nondefaulted federal loan borrowers are eligible for.
[Learn the timeline of federal student loan delinquency, default consequences.]
If the borrower can’t afford that amount, the loan holder is required under the new rules to offer a recalculated amount based on the borrower’s expenses and income. This option allows the borrower to submit a financial hardship form, where the borrow fills out his or her current expenses, including housing, food, clothing, etc.
Those expenses are taken into account and a new, often lower, payment amount is offered. The payment under either option can be as low as $5 per month.
And here lies the breakdown and the real issue with the anticipated redefaults. Once the borrower is finished with his or her nine-month rehabilitation payments and resumes regular repayment with a loan servicer, the borrower has no repayment options available for nondefaulted loans that will take expenses into account when determining the borrower’s required monthly payment amount. Income is considered but not expenses.
Consider that, under the rehabilitation plan, the first calculated payment is the same as for an income-driven repayment plan — often one of the lowest payment options available for nondefaulted loans — and that the borrower has stated she can’t afford . As such, she’s essentially set up to fail after rehabilitation by being given the lower, recalculated payment amount in the rehabilitation plan because she will not be able to duplicate that payment once out of default.
If she does default again , collection costs are charged again for a total that can result in almost half of the loan balance and the inability to rehabilitate that loan a second time.
It’s important to note that the recalculated rehabilitation amount was recently enacted with good intentions for the consumer. Advocates of the change wanted to ensure that rehabilitation options and benefits were available to all borrowers regardless of financial situation.
Full disclosure: The Student Loan Ranger was one of the negotiators at the negotiated rulemaking session that put this rule into place. While we voiced our concerns about setting borrowers up to redefault, we certainly agreed with the intent behind the rule change.
We agree with the Consumer Financial Protection Bureau that the transition between the conclusion of a successful rehabilitation program and the borrower ‘s new servicer and payment plan needs additional hand-holding, but we feel strongly that this alone will not stop the predicted redefaults.
We urge borrowers at the beginning of the rehabilitation process to ensure they know what their payments will be after default and determine if they can afford them. If not, it may actually be better for the borrower to stay in default for a little while longer, until his or her financial situation improves, rather than risk the consequences of defaulting a second time.
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Student Loan Borrowers Should Be Wary of Defaulting Again originally appeared on usnews.com
