The Tide Towards Tightening Regulations of Educational Loans

Legislators and regulators are proposing remedies to rising defaults on educational loans in the so-called "student loan bubble".

In an attempt to hold educational institutions partly responsible for defaults, a bill was introduced in the Senate which would impose "risk-sharing payments" on certain institutions that participate in direct federal student loan programs.¹ Those institutions where 25% or more of the fiscal year's students borrowed under those programs will be subject to the payments if they have high default rates.  The payments would be from five to twenty percent of the total of the institution's defaulted loans, including interest and collection costs.  The payments would be waived or reduced if the institution has a "student loan management plan" approved by the Secretary of Education.  To be approved, the plan must contain an analysis of the defaults and an action plan to address them.  It must also include individual financial aid counseling and strategies to reduce defaults and delinquencies.  This would at the very least impose an underwriting responsibility on educational institutions that are usually born by financial institutions.

A pair of bills currently pending would amend the Truth in Lending Act to require private lenders obtain a certification from the school of the student's enrollment, the cost of attendance, and the difference between the cost of attendance and the student's financial assistance.²  A second set would require the institutions provide the Secretary of Education with data on its student loans and post the data online, including the average amount of the loans, and the percentage of students who have loans and obtained their degrees, and the median earning of graduates for each specific degree.³

The Dodd-Frank Act created a student loan ombudsman within the Consumer Financial Protection Bureau to oversee complaints about private student loans. According to the most recent report,⁴ the complaints mirror those made in the mortgage industry after the housing collapse. They include violations of the Servicemembers Civil Relief Act, payment processing errors, and inability to modify or refinance the loans.  

Most of the complaints are about failed attempts to modify loans.  The CFPB opines that more flexible modification options would improve collections and add to borrowers' spending power, thereby spurring more mortgage and automobile loans. It cites in approval a joint statement by the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System that they "will not criticize financial institutions for engaging in prudent workout arrangements with borrowers who have encountered financial problems, even if the restructured loans result in adverse credit classifications or troubled debt restructurings in accordance with accounting requirements."⁵  The unstated hope is that without these worries, student loan lenders and servicers will be more likely to modify loans.

Finding many of the same issues in student loan servicing as were found in the mortgage servicing industry, the ombudsman suggests a study to determine if regulations recently imposed by RESPA on mortgage servicers could be applied to student loan servicers.  RESPA Regulations that were cited included regulating the transfer of loan servicers, improving borrowers' access to accurate payoff statements and loan histories, and requiring servicers designate customer representatives who have the authority to address borrowers' issues.

Likewise, it proposes to study whether some provisions in the Credit CARD Act of 2009 should be applied to servicers.  Specifically mentioned were the timing of statements and disclosure of the amount the borrower would pay if only the minimum payment is made. The ombudsman found the biggest problem, however, was the application of extra payments and underpayments. Because it will result in the most savings to borrowers, the ombudsman believes extra payments should be applied to the loan with the highest interest rate, not divided evenly or pro-rated with other loans.  When an underpayment is made, the ombudsman found that it was often pro-rated between all loans, resulting in late fees on all of a student's loans. The better practice is to progressively apply it starting with the lowest loan balance to prevent a default and late fees on at least one of the loans, if possible.

The CFPB stated that action must be taken unless student loan lenders and servicers voluntarily make the suggested changes.  This should serve as a warning and policies should be reviewed.  The tide is moving towards more regulation of the student loan industry.

¹  S.1873 by Sen. Reed, Jack D-RI, currently referred to the Committee on Health, Education, Labor, and Pensions.
²  S.133 by Sen. Durbin, Richard D-IL, currently referred to the Committee on Health, Education, Labor, and Pensions and H.R.3612 by Rep. Polis, Jared D-CO-2, currently Referred to House Financial Services.
³  S.915 Sen. Wyden, Ron D-OR, currently referred to the Committee on Health, Education, Labor, and Pensions and H.R.1937 by Rep. Hunter, Duncan D. R-CA-50 currently referred to the Subcommittee on Higher Education and Workforce Training.
⁴  October 2013 Annual Report of the CFPB Student Loan Ombudsman
⁵  Citing Banking Agencies Encourage Financial Institutions to Work with Student Loan Borrowers Experiencing Financial Difficulties, available at http://www.fdic.gov/news/news/press/2013/pr13065a.pdf (July 2013).