How Student Loan Companies Are Causing More Defaults

The Consumer Financial Protection Bureau finds significant problems are affecting most borrowers in the student-loan industry, which it highlights in its latest report.

In the analysis of federal student loan servicers data, the CFPB found that nine in 10 borrowers who defaulted on their loans and then resumed on-time payments – “a process known as “rehabilitation” – were not enrolled in federal affordable repayment plans even though they likely qualified.

As a result of that failure, close to half of those borrowers will default again on their loans within three years, according to the CFPB.

“When student loan companies know that nearly half of their highest-risk customers will quickly fail, it’s time to fix the broken system that makes this possible,” said CFPB Student Loan Ombudsman Seth Frotman in a press release.

Under the current system, student loan borrowers in default have two ways to get back on track.  They can “rehabilitate” their loan by making nine on-time payments over 10 months to debt collectors that government has hired. The collector then transfers the borrower to a loan servicer who can help enroll the borrower in an affordable repayment plan. Rehabilitations account for 70% of federal student loan collections.

The other option is for borrowers to refinance their debt with a new federal Direct Consolidation loan, which immediately enrolls them in an affordable repayment plan, also known as income-driven repayment (IDR). Ninety-five percent of such borrowers don’t default again within the first year, and at the three-year mark their default rates are about one-third lower than the rate of borrowers not enrolled in an affordable repayment plan.

The latest CFPB study is based on data from loan servicers of more than 20 million student loan borrowers, including the more than 600,000  who had recovered from at least one student loan default — borrowers the CFPB refers to as the “highest risk borrowers.”