How to Dig Out of Federal Student Loan Default

http://www.nytimes.com/2016/10/22/your-money/how-to-dig-out-of-federal-student-loan-default.html

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THE main option for getting federal student loans out of default is so flawed that borrowers who do manage to get back on track often end up defaulting again, a new report finds.

An estimated one in three struggling borrowers who complete a “loan rehabilitation” will default again within two years, according to a report published this week by the Consumer Financial Protection Bureau’s student loan ombudsman.

The report from the ombudsman, Seth Frotman, cited servicing gaps and “needless red tape” in the rehabilitation process as major hurdles to borrowers’ attempts to climb out of default and stay there. The report estimated that 200,000 borrowers would redefault over the next two years.

“Far too many borrowers are falling through the cracks,” Mr. Frotman said in a phone interview.

The default rate for new federal student loan borrowers has been declining over the last three years, according to an analysis by the Institute for College Access and Success. But the institute said, the total number of borrowers in default continues to grow, and is now a record 8.1 million.

When borrowers stop making payments and default on a federal student loan, they can make things right, and qualify for programs that offer reduced monthly payments, by agreeing to rehabilitation. Typically, borrowers work with a debt collector to make nine on-time payments — which can be as low as $5 — to clear the default. After that, most borrowers are eligible to switch to a traditional loan servicer and apply for flexible repayment programs that offer monthly payments as low as zero, depending on their financial circumstances.

But borrowers have complained about problems at all stages of rehabilitation, the ombudsman’s report found. In some cases, borrowers have said payments they made to debt collectors were calculated incorrectly or were not properly credited to their account. In other cases, borrowers said that after completing rehabilitation, lost paperwork and poor communication between collectors and loan servicers delayed their enrollment in flexible repayment programs. In the meantime, they were asked to make higher payments that they could not afford.

The report cited a complaint from a borrower who faced immediate delinquency after completing rehabilitation because his monthly payment jumped to $1,000 when his account was transferred to a new servicer. His debt collector, he said, failed to provide details about his financial circumstances to his servicer.

“Debt collectors could do a better job at counseling and preparing borrowers for the transition,” Persis Yu, director of the Student Loan Borrower Assistance Project at the National Consumer Law Center, said in an email. And servicers, she said, can do a better job of enrolling borrowers in flexible payment plans.

Ms. Yu said the report suggested that the system for fixing defaults may put some borrowers in a worse position than when they started. Borrowers can use rehabilitation just once, she said. So if they again enter default, they may remain there indefinitely and suffer financial consequences, including damaged credit, wage garnishment and seizure of their income tax refunds.

Here are some questions and answers about loan rehabilitation:

What other options are there for getting federal student loans out of default?

Borrowers in default can also choose to consolidate their loans into a new loan and immediately enter a flexible repayment program. Consolidation may be quicker than rehabilitation and offers other benefits, like the option to select your loan servicer, according to the Student Loan Borrower Assistance Project.

But consolidation may add higher fees to your balance, and it may take longer to restore your credit. Still, once borrowers fully understand their options, many choose consolidation, the project says. The project offers a comparison of the two options on its website.

One factor in the prevalence of rehabilitation, Ms. Yu said, is that debt collectors who contract with the federal government have a financial incentive to direct borrowers into rehabilitation. Collectors may receive as much as $1,710 for each loan rehabilitation, compared with $150 if the borrower consolidates, according to the project’s analysis.

What can I do to help make the rehabilitation process go smoothly?

The consumer bureau is strongly urging policy makers to simplify the process and give borrowers a clear, consistent path out of default, Mr. Frotman said. In the meantime, borrowers should be as diligent as possible about staying in contact with collectors and servicers, checking if payments are being properly applied and keeping up with the necessary paperwork to help the transition out of default go smoothly. If borrowers run into problems, he said, they should file a complaint with the bureau.

Where can I get information about affordable repayment programs?

The Education Department offers a repayment estimator on its website.

The Consumer Financial Protection Bureau offers a repayment tool, as well as sample letters to send to loan servicers.