The Horrors of Defaulting on Education Debt
November 12, 2009
A Few Additional Observations
Borrowers who dispute the legality and accuracy of charges piled onto their federal student loans are often unwilling to use income-contingent or income-based repayment because this requires them to affirm the validity of the loan amount. Once the loans are consolidated, they have little or no recourse against the original lender since the consolidation loan is a new loan that pays off the original loans. So even though the alternate repayment plans could provide them with significant repayment relief, they adamantly refuse to take a step which would let the lenders “get away with it” and legitimize the debt.
A tenfold increase in the amount owed is often due to extended period of nonpayment and the impact of collection charges. With federal education loans the collection charges are deducted from each payment, but with private student loans the collection charges are tacked on to the amount owed. (If a borrower consolidates defaulted federal education loans, up to 18.5% in collection charges can be added to the loan balance.) Collection charges on federal Stafford and PLUS loans are capped at 25%, but can reach 40% on Perkins loans. Private student loans can charge even higher collection charges. Also, while federal law requires collection charges to be reasonable, in practice the charges are based on an average figure, not the actual cost of collection. Even with the federal collection charges being deducted from payments, the high charges can double the term required to repay the debt.
Defaulted borrowers often have greater sensitivity to the cost of the loans. It is unclear whether this sensitivity existed before the default, but certainly after the default they find the total interest paid to be outrageously high. Most borrowers will hesitate when the total interest over the life of the loan exceeds the amount borrowed. This is an interesting psychological barrier, even though just a penny of interest means the borrowing is repaying more than the amount borrowed. With defaulted borrowers the threshold is lower, perhaps in part because long deferments and forbearances or long periods of nonpayment (sometimes due to circumstances beyond their control) have caused the loan balance to grow much larger than the original loan amount.
For example, a student borrowing $10,000 through the Stafford loan program at 6.8% interest will pay a total of $3,810 in interest and $13,810 in total over the 10 year term of the loan. If the student instead borrows from a private student loan program charging 10% interest, the borrower will pay a total of $13,162 in interest and $23,162 over the 20 year term of the loan. With defaulted borrowers the collection charges result in a slower repayment trajectory, usually doubling the repayment term and the total amount repaid.