A 2012 report1 from the Director of the Consumer Financial Protection Bureau (“CFPB”) and the Secretary of Education found that, as of the end of 2011, more than $8 billion in private student loans were in default and that even more were delinquent.2 This growing problem has not slowed down investors as more than $4 billion of private student loan asset-backed securities were issued in 2012. This year through February, dealers sold $5.6 billion of private student loan asset-backed securities, and the demand for the riskiest tranche of an issuance by Sallie Mae in late February was reportedly 15 times greater than the supply.3 On the other hand, lawmakers appear more concerned; several have introduced legislation to reform the U.S. Bankruptcy Code to allow borrowers to discharge their private student loans.4 Now, in another effort to address the issue, the CFPB has requested information from market participants, consumers, and other stakeholders on how to promote private student loan modifications.
The CFPB’s request for information implements a recommendation in the Annual Report of the CFPB Student Loan Ombudsman (“Report”), dated October 16, 2012. The Report identifies numerous issues that borrowers experience while trying to refinance or modify their private student loans.5 The vast majority of issues related to servicing, and the most common problem that the Report described was difficulty negotiating a repayment plan with the servicer when the borrower was experiencing unemployment, underemployment, or financial hardship. Borrowers also reported having difficulty refinancing their loans to lower interest rates that reflected their improved credit histories. Other reported servicing issues included servicers providing conflicting instructions to borrowers and an inability to contact servicers to correct mistakes in how payments were credited to borrowers’ accounts.
The Report offers several recommendations. One is to assess whether steps that have been taken to correct problems in residential mortgage servicing could be used to improve the quality of student loan servicing. The Report explains that similar market forces may act on both student loan and residential mortgage servicers. Student loans and residential mortgages are often securitized after they are originated. Lenders and investors in both areas rely on servicers for the routine collection of payments, and servicers may have inadequate incentives and capabilities to assist distressed borrowers. Student loan borrowers also cannot easily obtain a new servicer because they are limited in their ability to refinance. The Report notes that these factors can result in servicers under-investing in servicing processes. Policymakers and regulators have already decided it is necessary to provide more oversight of residential mortgage servicers and, given the similar market forces acting on student loan servicers, the Report suggests that the requirements and guidelines used to correct and contain residential mortgage servicing errors might be applicable to student loan servicing.6
Another recommendation is to identify potential opportunities to facilitate student loan modifications. According to the Report, many entrepreneurs and small financial institutions are eager to serve student loan borrowers who are seeking to refinance into lower interest rate loans, but those entrepreneurs and small financial institutions face capital constraints or other impediments. The Report also suggests that if borrowers cannot modify their private student loans, they would be better able to meet their obligations by reducing their federal student loan payments through Income Based Repayment ("IBR"). IBR is a federal repayment plan that allows qualified borrowers to reduce their monthly payments to a percentage of each borrower’s discretionary income and provides for loan forgiveness if certain conditions are met. The Department of Education, Department of the Treasury and Internal Revenue Service have already collaborated to streamline the IBR application process and further simplification and borrower awareness of IBR could create positive spillover effects in the private student loan market.