Proven private-sector practices can bring down student loan defaults

Why are delinquency rates still rising for student loans while those for mortgages, home equity lines of credit, auto loans, and credit cards are all declining now that the economy is recovering?

And how can public policies help student borrowers avoid delinquency?

{mosads}The New York Fed’s recent Quarterly Report on Household Debt and Credit for the fourth quarter of 2014 revealed that delinquency rates are not improving across the board and over 9 years defaults are as high as 26 percent.

The problem is: There continues to be more widespread misunderstanding about the terms, conditions, repayment and impacts of student loans than for any other federal loan or subsidy programs.

Why?

The rules for private student loans, mortgages, credit cards and other consumer loans have all been tightened, and these sectors are reporting record low rates for delinquencies and defaults. But federal student loans throw many private sector best practices and rules out the window with predictable results: excessive borrowing and high defaults.

Yes, there have been great efforts to simplify the FAFSA (Free Application for Federal Student Aid). But, with multiple websites, hosted by some 11 loan servicers, as well as the U.S. Department of Education itself, and no mobile platforms with any standardization, the student loan program’s online presence is confusing, not user-friendly. In short, the Education Department disburses almost $100 billion annually in loans very well. But the Department doesn’t do nearly as well at promoting responsible financial behavior by student borrowers.

Learning from the best practices in the private sector, public policymakers can take five steps towards reducing student loan defaults.

First, we need a real “truth in lending” policy towards student loans, beyond the new Simplified Award Letter that student borrowers now receive. Such essential information as the estimated total costs of borrowing, the potential salaries in their fields of study, and an estimated return on their investment in college education should be available on the Web for students and their parents.

Second, we need to go where the students are. This means offering robust, Web-based services, including mobile platforms. Let’s use the National Student Loan Data System database to present all the information on one website, for all borrowers. Allow students the ability to self-service themselves via mobile apps on their mobile device. This site should interact with students via in-app notifications and other action-forcing events. This functionality has been adopted in the private sector with great results. The Education Department must also consider the same approach.

Third, students must be required to participate in, and colleges must be tasked with providing, financial education each time that a student loan is disbursed and every year that a student re-enrolls in school. This should be accompanied by an updated TILA-like disclosure. When students start managing loans and understanding their terms from the moment when they enroll in college, excessive borrowing will also be reduced.

Over the term of a loan, more intensive personalized counseling would be triggered by objective risk factors such as missing a payment, missing classes, dropping out of school, or unsatisfactory academic progress.

Fourth, we should simplify the ways in which payments are made. Let’s allow payments directly to the U.S. Treasury, through voluntary payroll deductions through employers. This will help those who are under- or unbanked to make payments via ACH at no cost to anyone, including taxpayers. There is no need for payments to have to go only through federal servicers. Let’s also make it possible to make payments with credit and debit cards, negotiating the terms on the interchange rate. And let’s allow third parties, such as parents, to make payments on behalf of students via a single portal.

Fifth, as I have suggested before, bring the private sector into the servicing function instead of reserving it for the oligopoly of former guaranty agencies. Banks and other private financial services firms are experts as they have shown in controlling delinquencies on private student loans, mortgages and credit cards. Students will have a vastly different experience when they are presented information and data in a manner they can consume it easily and quickly.

It is important for students to develop relationships with their servicers, starting when they first take out their loans. More than 70 percent of the students who go into default have never talked to a servicer. But, if a borrower has been in touch with a servicer from day one, the probability of default declines dramatically to less than four percent.

For the past half-century, the student loan program has helped our country to benefit from an educated population. By leveraging what the private sector knows about financial education, we can solve the challenge of student loan defaults.

Rajan is president and CEO of Ceannate Corp, a leading business process outsourcing firm focused entirely on the students and institutions in the post-secondary education sector.