Getting Private Collection Agencies Out of Federal Student Loans

People listen to a speech on college affordability in Denver, Colorado, October 2011.

Every year, the U.S. Department of Education pays hundreds of millions of dollars to private companies that hound defaulted student loan borrowers to repay. Now, a group of 12 senators is pressing the Education Department to justify the expense or eliminate the use of private collection agencies entirely. Fittingly, their letter comes just a week after the Education Department awarded contracts worth a total of $400 million to two collection agencies, including one in which Secretary DeVos invested when she was a private citizen.

The senators’ letter is shining long-overdue light on the most broken part of the federal student loan system: what happens to the nearly 7 million former undergraduate, graduate, and parent borrowers in default on federal loans. Taxpayers and defaulters foot the bill for millions of dollars in fees and commissions each year, but their investment has poor returns. The collection system brings in a tiny fraction of outstanding debt and does little to foster long-term repayment success for borrowers who manage to get out of default. Even worse, it compounds the difficulties of defaulters, many of whom dropped out of college and/or are first-generation college students, individuals of color, or students with children.

With Congress calling for greater investigation into and transparency around private collection agencies, it’s important to understand what these companies are, how they got involved in federal student loans, and why now is the time to show them the door.

The role and history of collection agencies in federal student aid

When federal student borrowers fail to make payments for 270 days, they are transferred from a regular loan servicer to a private collection agency (PCA). While both servicers and PCAs are federal contractors, PCAs have the authority to pursue defaulters much more aggressively than loan servicers, including persistently contacting borrowers and withholding federal benefits to pay down debts.

Debt collection is big business for the companies with federal contracts. According to spending estimates, the Department of Education paid the 30 companies collecting loans from defaulted borrowers more than $700 million last year, about $100 million less than it spent on loan servicing for more than 33 million borrowers whose accounts are in good standing. Due to contracting changes, 15 agencies will collect on new defaulters going forward.

The Education Department first brought collection agencies on board when it began the Direct Loan program in 1992. At that time, there was only one loan servicer, ACS, which serviced all borrowers’ accounts when they entered repayment. Its responsibilities were the same as the nine current loan servicers, which bill students, process payments and postponements, and counsel students on repayment options. (Although loan collection differs somewhat for the defunct bank-based federal loan program, those borrowers experience similar issues as Direct Loan borrowers.)

Collection agencies treat accounts much differently than servicers, whose role is to get borrowers on manageable payment plans. For example, collection agencies can refer accounts to the Treasury Department, which withholds borrowers’ tax refunds or forces employers to garnish up to 15 percent of a borrower’s wages to pay down outstanding debts.

Why collection agencies should become a thing of the past

On principle, the use of private collection agencies is antithetical to the goals and purposes of student aid. Federal aid programs provide financial assistance so that students can pursue postsecondary education regardless of their financial situation. Collection agencies have one mission: Get borrowers to pay, no matter what. When an aid-focused organization partners with a profit-focused organization, a fundamental tension is created that is difficult to resolve.

The Office of Federal Student Aid (FSA), which manages the nation’s financial aid programs and student loan collectors, considers itself a student-focused organization. Its strategic plan counts integrity, customer service, excellence, and respect among its “core values.” If the FSA truly wants to embrace those values, however, it must prioritize providing borrowers with the best possible experience, even when they default—not blindly pursue collections at all costs. This is especially important for promoting equity within the U.S. financial aid system, considering borrowers who default are more likely to be students of color, low-income students, and noncompleters.

Philosophical arguments aside, PCAs also fail other key metrics of success: providing services of value; offering return on investment; and fostering long-term student success.

There are five major problems with private collection agencies.

1. Loan servicers could fill the role of PCAs

On paper, PCAs appear quite successful. In 2016, they recovered about $8.7 billion in defaulted federal student loan debt. But around 90 percent of this amount was never actually collected. Rather, it represents loans that borrowers took action to remove from default through rehabilitation or consolidation. About 75 percent of “recoveries” made by collection agencies were comprised of borrowers rehabilitating out of default, while about 13 percent were consolidated. In fact, only 4 percent of debt recovered—$354 million—was actually made through payments to PCAs. That’s about half the amount the Treasury Department took in from garnishing borrowers’ wages. In other words, the vast majority of successful PCA collection efforts represents the leveraging of federal tools.

Apart from historical practice, there is no reason that loan servicers cannot use those same federal tools to help borrowers. Servicers already perform similar duties: They try to contact delinquent borrowers; they help borrowers consolidate their loans; they counsel borrowers on repayment plans, which is similar to walking them through rehabilitation; and they report the status of borrowers’ accounts to the federal government and credit reporting agencies, which is akin to referring borrowers for wage garnishment. Why pay for an entirely separate set of contractors when an existing set could do the job?

2. The federal government spends too much money on collections

The federal government spent about $700 million in 2017 on debt collections for a little fewer than 7 million borrowers in default. That’s nearly the same amount that it spent on loan servicing for the more than 33 million borrowers who are actively repaying their loans. Although defaulted borrowers may need more outreach, those funds could be better spent on keeping borrowers out of default, rather than chasing them down after they default.

3. The Department of Education has to overpay collectors to achieve better outcomes for borrowers

Private collection agencies have one goal: Get borrowers to pay. But the federal student loan system is unique in that it provides an out for borrowers who are looking to resolve their default. Thus, the federal government often has to overpay PCAs so that their incentive is properly aligned to help borrowers. For example, the federal government pays $1,710 for each borrower successfully rehabilitated by a collection agency—a substantial sum designed to ensure that PCAs push for rehabilitation. Yet about 80 percent of borrowers pay just $45 to rehabilitate their default, resulting in the government paying nearly $40 for every $1 collected. That is not a good return on investment, especially considering that defaulters—largely those who the U.S. postsecondary system has not served well—bear some of that cost burden.

4. Collection fees borrowers pay are not tied to how much PCAs spend working their accounts

While the government overpays collectors in some cases, it is often defaulters who get stuck with exorbitant fees. Federal law requires that borrowers pay reasonable collection costs. In theory, collection fees are supposed to roughly reflect the actual costs that the agency incurs. In practice, however, they are often just set at high levels. For instance, when borrowers default, they are immediately assessed collection costs that can be up to 25 percent of the defaulted loan balance. Then, when borrowers make a payment to a PCA, roughly 20 percent of that amount is first applied to collection fees, meaning that borrowers may be barely chipping away at their defaulted loan balance.

There is also no direct connection between the collection fees that borrowers pay and the actual cost of their work. Instead, collection fees are set by the Department of Education and are based on the average cost of collecting defaulted loans. The lack of a direct connection between collection costs and borrower charges means that PCAs can maximize their profits by putting a minimal amount of work into recovering defaulted debt. This is exacerbated by the fact that amounts collected by the government through wage garnishment result in just as high a payment to collectors as a voluntary payment submitted by borrowers. Meanwhile, PCAs get paid for recovering the debt and are able to profit again when the account returns to collections.

5. PCAs do not do anything to promote good long-term outcomes for borrowers who get out of default

The sky-high fees to PCAs might be worth it if they set borrowers up for long-term success. Instead, the existence of collection agencies complicates the process of getting out of default. When borrowers are passed from servicers, to collection agencies, then back to servicers, the continuity of their repayment process is inevitably disrupted. So even when borrowers resolve their default and re-enter repayment, their risk of default remains high. The Consumer Financial Protection Bureau confirmed this in a 2017 report, showing that even borrowers who are initially put into a more affordable repayment plan have high rates of redefault, with more than 40 percent of rehabilitated loan borrowers defaulting again within three years.

Cutting out the middlemen

The Department of Education can go forward without collection agencies, instead relying on loan servicers to manage borrowers’ accounts. If the federal government allowed servicers to continue to work defaulted accounts, borrowers would have a consistent point of contact and servicers would develop a more in-depth knowledge of individual borrowers’ repayment history and what servicing practices best work for them.

Getting rid of PCAs would also free up hundreds of millions of dollars that could be siphoned into loan servicing, which would allow those companies to provide better service to borrowers. Collection fees could be greatly reduced, if not eliminated, and borrowers would experience more continuity throughout the repayment process. This would not only make loan repayment simpler, but it could also drastically decrease the number of borrowers who default and redefault. This does not mean that defaulted borrowers would suddenly get off without consequences, but it does mean that borrowers would be working with agencies whose values and goals are properly oriented toward repayment success.

Unfortunately, Secretary DeVos seems to support private collection agencies. One of her first actions upon entering office was to allow agencies collecting older federal loans to charge collection fees on borrowers who rehabilitated within 60 days of entering default. She was even an investor in a collection agency that had—and was just awarded a new—federal contract.

But pressure from Congress and student advocates can ultimately turn the tide against collection agencies. The Department of Education is required to respond to the senators’ letter by February 13, at which time the public will learn more about the path that Secretary DeVos and A. Wayne Johnson, chief operating officer of Federal Student Aid, will take going forward. Those concerned about this issue should contact their senators to push them to oppose collection agencies, whose elimination would lead to better loan repayment outcomes for millions of borrowers.

Colleen Campbell is the associate director for Postsecondary Education at the Center for American Progress.