There are 23 private debt collection agencies that are contracted with the U.S. Department of Education to collect on defaulted federal student loan debt. You can see the full list of these agencies here. Together, these agencies recovered over $13 billion in defaulted federal student loans last fiscal year.
Their incentive? Commission. When a borrower defaults on federal student loans, the U.S. Department of Education can tack on 18.5% of the entire principal and interest balance as “collections costs,” a massive penalty that the borrower will have to repay. Other federal loans have even higher collections costs. So for a loan amount of $100,000, an additional $18,500 can be added as collections costs if the borrower defaults. Most those fees (16% of the total loan balance) go to the debt collection agency contracted with the U.S. Dept. of Education, so long as the collections agency obtains certain levels of payments from the borrower based on the loan balance. This provides an incentive for the agency to demand large payments from the borrower, even though federal law requires that the borrower be allowed to make “reasonable and affordable” payments based on their individual financial circumstances.
The Obama administration recently reduced the collections agency commission for U.S. Dept. of Education loans from 16% to 11%. Furthermore, there has been a major policy change: the collections agencies will collect that 11% fee regardless of the payment amount they are receiving from the borrower (provided the borrower gets out of default by making payments). Thus the incentive to demand higher monthly payments from borrowers is reduced, and the collections agencies can now offer “reasonable and affordable” payment schedules without the risk of losing their commission. While this change does not address the serious burdens and costs of defaulting for borrowers, it does provide borrowers with some relief in terms of making payments to get out of default, and that’s a good thing.
To read more about this development, click here.