Student Loans: The Future of Collections and Repayment

Many Americans are faced with repayment of outsized student loan debts. And, as each new class matriculates to college, they too join the ranks of those faced with the prospect of financing their education and repaying the amount borrowed over the course of their careers. With limited options for forgiveness and payment relief, many will struggle to repay for their college over a period of decades.

On the other hand, creditors and loan servicers face anxiety associated with collecting outstanding balances. They are tasked with complying with the Consumer Financial Protection Bureau’s new Debt Collection Rule and with navigating a regulatory environment where state attorneys general demonstrate an increased willingness to hold them accountable under state laws designed to curb deceptive acts and practices.

The Growing Problem

Many students now use student loans to pay for their college education. While these programs provide resources for students to achieve their goals of attending college, debt-saddled graduates struggle to make ends meet as they begin their careers. Increasing enrollment and a cost of education that well outpaces the growth of median household incomes means that these financial struggles are going from endemic to pandemic. These factors, further magnified by inflationary concerns, are fueling a public dialogue about how the nation is to confront this most rapidly growing sector of consumer debt.

Student loans can generally be of one of two types: private loans and federally-backed loans. Relief options for private loans, if any exist, are limited to those the loan servicer is willing to offer and vary by lender. Federal loans, on the other hand, present some unique characteristics. First, they come with a suite of repayment options, including include income-driven or income-based repayment options. Simply put, these programs derive the amount of the monthly payment on a loan from a borrower’s income (recertified annually) rather than on a traditional amortization schedule. Some of these programs offer loan forgiveness after completion of a set number of payments regardless of the amount of the unpaid balance (although a lingering problem remains in that a 1099 form may be issued for forgiven amounts, resulting an unwieldy amount of taxable income being reported for a borrower). One drawback to federal loans, however, is that the interest rate is set from inception and there is little ability to lower it absent refinancing into a private student loan—thereby losing the relief options available in the federal loan.

Another key feature of student loans is their (lack of) dischargeability. While federal loans do discharge upon proof of death, private loans do not. Moreover, neither private nor federal student loans are regularly dischargeable in bankruptcy. Indeed, 11 U.S.C. § 523(a)(8) provides only a limited exception for circumstances where lack of a discharge would impose an “undue hardship.” Courts have grappled with how to frame an “undue hardship.” One commonly used test, the Brunner test, looks to factors such as (1) a debtor’s ability to maintain a “minimal” standard of living if forced to repay the loan, (2) circumstances indicating that a state of affairs will continue for the life of the loans, and (3) a good faith effort to repay the loans.

More recently, courts have criticized the Brunner test as overly harsh and instead offered a more debtor-friendly analysis in considering whether failure to discharge student loans would cause an undue hardship. While borrowers may rejoice at recent overtures by courts expressing willingness to discharge loans in bankruptcy, it only compounds creditors’ frustrations in trying to collect amounts due.

Recent Relief Efforts

As part of the COVID-19 pandemic relief, payments and interest on federal student loans have been paused since March 2020. Interestingly, each passing month counts toward the number of payments to be made before loan forgiveness for those on Income Driven Repayment plans. Private student loans, however, are not affected by the pause, and payments under those programs continue to be required.

Another commonly discussed student loan relief program is the Public Service Loan Forgiveness (PSLF) program. Similar to income-driven plans, PSLF provides the opportunity for borrowers to obtain forgiveness for the balance of their federal loans after making a certain number of payments. PSLF is unique, however, in that the payment period is shorter, the forgiveness is excepted from being taxable income, and qualification is based upon employment in a public service role. And, in October 2021, the US Department of Education has provided the opportunity for borrowers to receive credit for past periods of repayment that would not have otherwise been counted toward loan forgiveness under PSLF.

Finally, an additional significant wave of student loan relief exists for borrowers who attended schools which subsequently closed. The recent relief efforts for these borrowers extends beyond students who attended classes within 120 days of closure who already had been eligible for discharge and is related to the deception on the part of the closed institutions.

Collection Issues Abound

Confronted with new loan forgiveness programs, changes in attitudes toward discharge, and political uncertainty about broader relief efforts, student loan lenders and servicers face an increasingly difficult climate. In collecting loans, servicers also must be careful to monitor new regulations, including the CFPB’s new Debt Collection Rule. Effective in November 2021, the Debt Collection Rule was created to implement the Fair Debt Collection Practices Act (FDCPA), focusing on debt collection communications, harassment or abuse by debt collectors, false or misleading representations, and unfair practices.

State attorneys general also have shown a recent inclination to police improper actions by student loan servicers and to levy penalties for such actions. For example, 39 state attorneys general announced a $1.85 Billion Settlement with student loan servicer Navient in January 2022 for practices that steered borrowers into forbearance rather than toward available payment relief programs like income-driven repayment. This settlement and the implementation of the FDCPA through the Debt Collection Rule should serve as a weathervane indicating a change on both the federal and state levels, and must be carefully monitored.