When President Obama signed the controversial overhaul of the federal student loan program into law in 2010, he declared victory over "bankers and middlemen." To this day, however, the federal government continues to engage in some of the same deceptive lending policies private firms are frequently accused of practicing.
Most glaring, experts say, is an extraordinarily high collection penalty—up to 25 percent—imposed on students who default on their federal loans.
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"It just doesn’t seem all that fair," said Mark Kantrowitz, a student loan expert and founder of FinAid.org. Given the "very powerful tools" the government has to compel repayment—such as wage garnishment, the seizure of tax refunds, federal benefits, and lottery winnings—the 25 percent fee is "very high," he told the Washington Free Beacon.
Though private lenders may charge similar fees, their collection rate is far lower, he said. A spokesperson for Sallie Mae, the largest private student loan purveyor in the country, told the Free Beacon the company "does not assess collections fees when a private loan defaults."
Kantrowitz said some students could end up spending an additional nine years repaying a federal loan (on a standard 10-year plan) in order to cover the cost of the fee.
"It's the kind of draconian penalty that would have critics up in arms if it was being imposed by a private lender with the government's dominant market share," writes Fortune magazine’s David A. Kaplan, who notes that one in six student in default are assessed the 25 percent penalty, even though many do not end up paying the full amount.
Not only is the collection fee exceedingly high, it is almost entirely hidden from prospective borrowers. There is no mention of the 25 percent charge on the master promissory notes students must sign before receiving a federal loan, just a warning that defaulting borrowers can be subject to "collection costs."
Of the three government-affiliated websites providing information about federal student loans, only one actually states that "the amount needed to satisfy a student loan debt collected by the Department's contractors will be up to 25 percent more than the principal and interest repaid by the borrower." Others warn that "reasonable collection fees and costs" may be assessed.
Kantrowitz said the hidden fee was "a trade secret" for years until it was "accidentally" published in a procedures manual on loan collection practices.
In an effort to further combat these alleged grievances, the controversial Dodd-Frank Act of 2010 gave the federal government sweeping authority to regulate private student loans.
The Consumer Financial Protection Bureau (CFPB) established under the law is preparing to issue a wide-ranging report on the private student loan industry next month as part of its "Know Before You Owe" campaign.
It is not clear if the CFPB will apply the same scrutiny to the federal government’s own practices. The CFPB and the Department of Education (DOE) did not provide comment at the time of writing.
A recent study by the National Consumer Law Center (NCLC) found significant problems with the way the DOE evaluates the private collection agencies it employs to recoup student loans. The vast majority of a particular agency’s "performance" rating is determined by "the percentage of dollars collected on federal student loan accounts," the study found. Little to no consideration was given for "service quality" or the number of borrower complaints an agency received.
The collection agency with the highest DOE rating in 2011, NCO Group, had the most complaints filed against it between March 2011 and March 2012, and has been forced to settle a number of lawsuits alleging the use of "verbally coercive collection tactics, among other violations." A recent Bloomberg report documented how such agencies offer lucrative salaries to top executives, and derive most of their revenue from collections, as opposed to default-prevention programs.
The DOE experienced a 41 percent increase in complaints last year. The NCLC study found significant problems with the department’s complaint policy in terms of transparency and accessibility. "The Department does not direct borrowers to an e-mail or physical address where borrowers can submit their complaints … borrowers must navigate to a separate page within the Federal Student Aid website which lists a general phone number to call to make a verbal complaint."
"Balancing collection for taxpayers and relief to borrowers can be difficult, but the government has consistently favored school, lender, and collection industry profits over the needs of struggling borrowers," writes Deanne Loonin, who coauthored the NCLC study.
Student loans are a hot topic in Washington these days, as Congress debates how to finance a measure to extend the low 3.4 percent interest rate on student loans, which is set to expire in July.
A spokesperson for Elizabeth Warren, the Native-American Senate candidate who was almost tapped to head the CFPB, did not return a request for comment.