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Guest Post: Five Steps the Government Can Take to Help Private Loan Borrowers

[Editor's Note: The National Consumer Law Center is releasing a report today asking the Obama administration and Congress to provide relief for financially distressed private loan borrowers. In this guest post, Deanne Loonin, the report's author, explains why these individuals are deserving of help and outlines steps federal officials can take to ease their burdens and protect future borrowers.]

By Deanne Loonin

For many years, private student loans generated steady, if unspectacular, profits for lenders. The business model was relatively conservative, providing loans mainly to graduate students and creditworthy borrowers. Over the last decade, however, the student loan industry turned that model on its head. Spurred by Wall Street, lenders began aggressively marketing expensive private loans to high-risk students with little ability to repay them. For the most part, these companies were eager to make these loans because they could securitize them and shift the risk onto investors.

The recent crash in the private student loan market should not have been so surprising. The writing was on the wall but, as so commonly occurred during the bubble economy, most chose not to read the warning signs. Most rating agencies continued to rate private loan pools highly, even after signs of trouble began to emerge.

Lenders have paid a price for their irresponsible practices. By all accounts, delinquencies and defaults on these loans are continuing to accelerate and investors have little interest in taking a stake in these loans.

But the heaviest price is being paid by financially distressed borrowers who never should have been stuck taking out these unaffordable loans to begin with. At the National Consumer Law Center's Student Loan Borrower Assistance Project, we have found private loan providers to be universally inflexible in granting long-term repayment help for these borrowers. Meanwhile, while the government is considering offering assistance to lenders so they can continue making private loans, it has yet to offer any relief to these borrowers.

Apparently federal officials have decided that these borrowers are "too small" to help. In reality, their numbers are large, but their political power is not. To the extent that their problems are exposed, it is generally through the voices of investors angry at crashing stocks and declining revenues.

In our report, we argue that these borrowers desperately need a safety net to give them some hope of escaping their debilitating debt and starting again. Among other things, we recommend that the government do the following:

  • Require private lenders and servicers that receive federal bail out assistance to offer loan modifications and other kinds of repayment relief to borrowers who are clearly struggling to repay their high-cost debt. Servicers should have the authority to modify loan terms, change interest rates, forbear or forgive principal, extend maturity dates, and offer forbearances, deferments, and other types of flexible repayment options. There is ample precedent in the mortgage sector tying loss mitigation and other consumer benefits to the receipt of federal funds.
  • Restore the rights of financially distressed borrowers to discharge private student loans in bankruptcy. As readers of Higher Ed Watch well know, the loan industry persuaded Congress in 2005 to make private loans as difficult to discharge in bankruptcy as federal loans.  As a result, borrowers who are too poor to repay their private loans are treated in the same severe way in bankruptcy courts as people who fail to pay child support, alimony, overdue taxes, and criminal fines.
  • Cancel the private loan obligations of borrowers who took on this debt to attend unlicensed, unaccredited trade schools that have shut down unexpectedly. As Higher Ed Watch has reported extensively, private lenders have partnered with unregulated trade schools to help students take on high-cost private student loans to attend these institutions, and then refused to cancel them when the schools shut down. These loan providers have spared no expense to try to prevent victims who challenge these practices from having their day in court. In the current environment where creditors are rewarded with bail outs for prior bad acts and where no one wants to take responsibility for the meltdown, taking action in this area is one small way to hold lenders liable for the damage they have done.
  • Impose more stringent regulations on the private loan market, including placing a cap on the interest rate and fees that private loan borrowers can be charged, and requiring lenders to strengthen their underwriting standards. Private loans should go only to borrowers who likely will be able to repay them, and they should be available at reasonable rates.
  • Strengthen consumer protection laws to expressly give victims of abusive lending practices the right to file individual and class action lawsuits against lenders and schools, and ban lenders from including mandatory arbitration clauses in loan contracts. Private loan borrowers who have been harmed currently have very little recourse because the loan industry often uses its market power to limit their access to justice.

Our report shows how an unsustainable business model helped lead to a credit crunch that has decimated our economy.  These unsustainable products were taken out by individuals trying to improve their futures.  "Unsustainable" in human terms means individuals who pursue their dreams of upward mobility, only to find that these dreams are shattered due to unaffordable debt loads that they will never be able to repay.  While it may be impossible to get all of these individuals back on track, it is clearly possible to help some. The fact that lenders are hardly trying is a national disgrace. We cannot truly begin to reshape the future and improve access to education without redress for those left behind.

Deanne Loonin is a staff attorney with the National Consumer Law Center and the director of the center's Student Loan Borrower Assistance Project. She focuses on consumer credit issues generally and more specifically on student loans, credit counseling, and credit discrimination. She is the principal author of numerous publications, including "Paying the Price: the High Cost of Private Student Loans and the Dangers for Student Borrowers." Her views are her own and do not necessarily reflect those of the New America Foundation.


Too Small to Help

From beginning to end, this report is right on -- except where you suggest that Congress restore a waiting period before discharging private student loans. I can hear the collective laughter of that fourth branch of government – the student loan lobbyists -- when they “reluctantly” agree to this “straightforward process.”

Bankruptcy law used to allow the discharge of student loans when the loans had been “in repayment” for a set number of years (five years, then seven years pre-1998). The truth is, the pre-1998 law that you infer was a “straightforward process”, was anything but. It was completely controlled by lenders and very few discharges were ever granted.

Several years ago, when there were still paper files to sift through, I researched this very subject. I spent many hours in the bankruptcy court basement reading through dozens of case files, and it wasn’t long before a shocking pattern emerged. Most loans were found to be non-dischargeable because of Judges, lender manipulation, and cost.

Bankruptcy judges have a deeply ingrained bias against student loan debtors. Eugene Wedoff called the treatment of student loans in bankruptcy, “punitive…despite the absence of wrongful conduct by the debtor.”

Lenders systematically employed a method of applying retroactive forebearances and deferments for the sole purpose of protecting the loans from discharge. Lenders cried to the Court about how they should not be penalized for "helping" borrowers. Judges agreed, and sided with lenders by adding back in the time these loans had been in forebearance/deferment -- even when forebearances and deferments had not been requested by the borrower. The burden was on the debtor to piece together five (or seven) repayment years -- An almost impossible task when records of legitimate forebearances and deferments had long ago been misplaced or lost, while the more numerous and longer imaginary forebearances and deferments which existed only in the minds and computer printouts of the lender’s were readily available and admitted into the record.

If you think this can’t happen again, consider that lenders have many years of experience under the old law of manipulating time periods, dates, paperwork and computer records. Similar shenanigans continue to this day. Case in point: A former Sallie Mae employee recently filed a whistleblower complaint in the state of Indiana, stating that telephone agents working for Sallie Mae on behalf of USA Funds routinely falsify borrower requests for forbearances, often just dialing a borrower’s telephone number and letting the line sit open for a few minutes while Sallie Mae’s computers record an apparent conversation. The agent then lists the borrower as having approved a forebearance, when no such approval occurred. The law requires the lender to send a written confirmation to the borrower by mail, but it doesn’t require any proof that the letter was received.

And what about the COST to the debtor of proving that their loan meets all the requirements for discharge? The debtor will be forced to file the dreaded Adversary Petition to determine the dischargeability of their student loans -- “dreaded” because bankruptcy lawyers dread filing them, and usually won't. “Adversary petition” sounds like a simple process, doesn’t it? Not! These are formal lawsuits that begin with filing a complaint, demurrers, cross complaints, discovery, depositions, interrogatories, and that’s just PRE-trial, all at a cost of tens of thousands of dollars. With the debtor’s bankruptcy attorney having exited the scene, the debtor is now left to go it alone against an army of student loan industry lawyers. Distressed low income debtors do not have the money or skill to navigate this legal obstacle course, let alone ever being able to meet the time-in-repayment requirements as the judges will interpret them (with a lot of help from the student loan industry).

Take this whole mess and multiply it times the four or five private student loans that debtors have, each loan with possibly a different lender, each loan with its own separate terms, forbearances, deferments and repayment history. This would be a daunting undertaking for even the most experienced bankruptcy attorney, who of course wouldn’t have touched it with a ten foot pole anyway.

Senator Durbin introduced truly straightforward corrective legislation in 2007 in SB 1561 allowing for the discharge of private student loans. No strings attached. No doors left open for the lenders to exploit. It is high time for Senator Durbin’s bill to be reintroduced. Change must occur that is neither fraught with minefields for the debtor, nor full of loopholes that favor lenders.

The report written by Ms. Loonin is excellent. It is a long overdue call to immediate Action. On the subject of bankruptcy, just be careful not to play into the hands of these predatory private student loan lenders by regurgitating an old law that will be no easier for bankrupt debtors to stomach now than it was then.

Five private loans from Sallie Mae.

I agree that that this is an excellent report by Ms. Loonin. I would like to know the best way to track Senator Durbin's bill? Now where do I start with my comments? It has been a long road since I graduated in 2005. When I graduated I had $45,000 in Government loans. The Government allowed me to consolidate the loans with a low interest rate. Needles to say, I am thankful. Sallie Mae has been a different story.

In response to Anon's comment about multiple private loans, I have five private student loans with Sallie Mae. All of the loans have different terms. The average interest rate on the five loans is 10.9%. This point alone is bad. What is worse, when I graduated in 2005 I owed Sallie Mae $100,000. Now, four years later, I owe them almost $140,000. For me, this is staggering.

A bit of this has been some irresponsibility brought on by me. I deferred payments when I had a job. The payments were high and I felt that I would be making better money in a year or two and that I would be in better position to make the high monthly payments. Then the economy fell from under our feet and all of a sudden I was unemployed when my deferments ran out. I am still unemployed, and I feel like I’m never going to get out of this mountain of debt.

Add to this that Sallie Mae had been under fire for some time about their questionable practices, and I feel like things are not in my favor. Two years after I graduated, Sallie Mae was under investigation for questionable business practices with certain schools and lenders. In 2007 they were ordered by New York Attorney General Andrew Cuomo, to pay $2 Million into a fund to educate students and parents about the financial aid industry.

Something has to change. I needed to write this. I am close to $200,000 in debt and I need help. I hope that others will tell their story. Please write your representatives.

It's a long shot but I have faith in Obama

I am one of those borrowers who can't repay my loans. I have been battling with Sallie Mae since 2005 and haven't gotten anywhere. I couldn't pay the bill when I first went into repayment status. Now my bills are for $287 a month. They always send me emails telling me they can help me but they can't, every 'option' I have I don't qualify for. I saw an 'income sensitive repayment plan" but very conveniently that's only for Federal Loans. I am now in default and I am scared crapless because I don't know what will happen to me now. I don't own anything but my car, which obviously I need to go to work. My wages and income tax return are at stake here. I am afraid that my credit will be ruined forever and I'll never be able to live the American dream of buying my first home someday or getting a new car when mine dies on me.
I agree that the majority of people in this country have some kind of debt other than student loan debt and there is ALWAYS a way out for them whether it be bankruptcy or just having the creditors work with them. But if you can't pay your private student loan then you might as well be sentenced to death - financial death - because that's what will happen to you. I don't make a lot of money, I'm stuck in a contractors position so I can't get medical benefits or have taxes even taken out of my check. I continue to work here because I like my job and it pays most of the bills. I have a 3 year old daughter and a husband. His pay is more than mine but not by much. I don't want to cry to you guys but you get the idea. The consumers in this country are who need bailing out- not big corporations and definately not private student loan companies!!!

Private School loan HELL. Will Obama help??????

I am in the same boat. My private loans are over 100,000 and collection interest, as we speak. I would rather be dead than everyday fear this unknown. I lost my job in January 2009 and am currently in my last 6 months of bankruptcy. Once that is over, they will come after me like I killed their mother. I don't want to live like this. What will they do to me? What can they take from me? How much of my low paycheck will they garnish? No more tax returns. My credit is doomed. I have no future. No more hopes and dreams of a great life. Just a fear of the UNKNOWN.

They can garnish up to 25%

They can garnish up to 25% of your wages or so they've told me. Two of my loans are now in collections. I have only recieved one letter from the collection agency and that was months ago. They don't call or anything. I guess they can start proceeding with the wage garnishment at any time, they don't have to send me tons of letters trying to get me to pay. I am getting back on track with the only loan that Sallie Mae still has. It's only $8 a month and I am paying $50 a month just to get it paid off. After that then I will deal with the collection agency.