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When a borrower defaults on his or her student loans, the lender may add collection charges to the cost of the loan. Usually the collection charges are deducted from each payment before the remainder is applied to the interest, fee and principal balance of the debt. But sometimes collection charges are added to the loan balance.

Collection charges are usually expressed as a percentage of the amount applied to the principal and interest balance of the loan. For example, if a defaulted borrower wishes to pay off his or her debt, this is the amount that must be added to the current loan balance to yield the payoff amount. Collection charges may also be expressed as a percentage of the total amount paid by the borrower.

The two figures are mathematically related. If D is the percentage deducted from the loan payment and P is the percentage of the amount applied to principal and interest, then D = P / (1 - P) and P = D / (1 + D). For example, if the collection charge rate is up to 25% of the payment amount, then the collection charges represent up to 25% / (1 + 25%) = 20% of the principal and interest portion of the payment.

A portion of the collection charges are paid to collection agencies who receive a commission based on the amount recovered. This gives the collection agencies an incentive to recover as much of the debt as possible. This also means that the collection agencies may not inform the borrower about less expensive repayment options, such as income-based repayment.

Collection charges are based on the average cost of recovering defaulted loans, not the actual cost of recovering the particular borrower's defaulted loan.

Current Collection Charge Rates

The current collection charges on defaulted federal Stafford, PLUS and consolidation loans is 19.58% of the payment. This is the equivalent of a payoff amount that adds 24.34% to the balance of the loan.

If a borrower rehabilitates a defaulted loan by consolidating the loan, collection charges of up to 18.5% are added to the loan balance. The US Department of Education may sometimes waive the collection charges when a borrower seeks a lump sum settlement of a defaulted federal student loan.

The Perkins loan has a higher collection charge rate, in part because the average defaulted Perkins loan balance is much smaller. The collection charges are 30% of the principal, interest and late charges for first collection attempts and 40% for subsequent collection attempts. Collection charges on a defaulted Perkins loan repaid through rehabilitation are capped at 24%.

Historical Collection Charge Rates

In response to a 2012 Freedom of Information Act (FOIA) request, the US Department of Education provided the following information:

• Before March 1995, the collection charges were based on actual charges from collection agencies, without any limits.
• From March 1995 through April 2008, the collection charges were 20% of the amount paid (25% payoff).
• From May 2008 to the present, the collection charges were reduced to 19.58% of the amount paid (24.34% payoff).

Unfortunately, this response is not entirely accurate. While the collection charges from May 2008 to the present are indeed 19.58% (24.34% payoff), as documented by a May 2008 letter to guarantee agencies, the collection charges for FY2007 were 19.36% (24.0% payoff) as documented by a March 2007 letter to guarantee agencies. The US Department of Education has not yet responded to questions concerning this discrepancy.

Several guarantee agencies stated that they did not retain copies of previous letters from the US Department of Education concerning caps on collection charges.

Reverse engineering the repayment history of a defaulted borrower yields the following collection charges at a particular guarantee agency. Notice how the collection charges almost doubled from 2004 to 2007.

Year	Percentage of Total Payment	Percentage of Principal and Interest
2012	20.0%	25.0%
2011	20.0%	25.0%
2010	20.0%	25.0%
2009	20.0%	25.0%
2008	20.0%	25.0%
2007	20.0%	25.0%
2006	16.2%	19.4%
2005	13.2%	15.2%
2004	12.1%	13.8%

Statutory and Regulatory Basis

Section 484A(b) of the Higher Education Act of 1965 [20 USC 1091b(b)] specifies that borrowers who have defaulted on federal student loans shall be required to pay "reasonable collection costs". A similar requirement appears in section 455(d)(5) of the Higher Education Act of 1965 [20 USC 1087e(d)(5)].

The Higher Education Act of 1965 does not, however, define reasonable collection costs.

Reasonable collection costs are defined in the regulations at 34 CFR 682.410(b)(2) as including attorney's fees, collection agency charges and court costs. The reference to 34 CFR 682.401(b)(27) concerns defaulted loans that were paid off by a consolidation loan. The reference to 682.405(b)(1)(vi) is to defaulted loans that are repaid through rehabilitation.

Collection charges. Whether or not provided for in the borrower's promissory note and subject to any limitation on the amount of those costs in that note, the guaranty agency shall charge a borrower an amount equal to reasonable costs incurred by the agency in collecting a loan on which the agency has paid a default or bankruptcy claim. These costs may include, but are not limited to, all attorney's fees, collection agency charges, and court costs. Except as provided in 682.401(b)(27) and 682.405(b)(1)(iv), the amount charged a borrower must equal the lesser of

(i) The amount the same borrower would be charged for the cost of collection under the formula in 34 CFR 30.60; or

(ii) The amount the same borrower would be charged for the cost of collection if the loan was held by the U.S. Department of Education.

The regulations at 34 CFR 30.60, which were referenced by 34 CFR 682.410(b)(2), provide additional detail.

What costs does the Secretary impose on delinquent debtors?

(a) The Secretary may charge a debtor for the costs associated with the collection of a particular debt. These costs include, but are not limited to

(1) Salaries of employees performing Federal loan servicing and debt collection activities;

(2) Telephone and mailing costs;

(3) Costs for reporting debts to credit bureaus;

(4) Costs for purchase of credit bureau reports;

(5) Costs associated with computer operations and other costs associated with the maintenance of records;

(6) Bank charges;

(7) Collection agency costs;

(8) Court costs and attorney fees; and

(9) Costs charged by other Governmental agencies.

(b) Notwithstanding any provision of State law, if the Secretary uses a collection agency to collect a debt on a contingent fee basis, the Secretary charges the debtor, and collects through the agency, an amount sufficient to recover

(1) The entire amount of the debt; and

(2) The amount that the Secretary is required to pay the agency for its collection services.

(c)(1) The amount recovered under paragraph (b) of this section is the entire amount of the debt, multiplied by the following fraction: 1 / (1 - cr).

(2) In paragraph (c)(1) of this section, cr equals the commission rate the Department pays to the collection agency.

(d) If the Secretary uses more than one collection agency to collect similar debts, the commission rate (cr) described in paragraph (c)(2) of this section is calculated as a weighted average of the commission rates charged by all collection agencies collecting similar debts, computed for each fiscal year based on the formula Sum(i=1..N,(Xi * Yi / Z)) where

(1) Xi equals the dollar amount of similar debts placed by the Department with an individual collection agency as of the end of the preceding fiscal year;

(2) Yi equals the commission rate the Department pays to that collection agency for the collection of the similar debts;

(3) Z equals the dollar amount of similar debts placed by the Department with all collection agencies as of the end of the preceding fiscal year; and

(4) N equals the number of collection agencies with which the Secretary has placed similar debts as of the end of the preceding fiscal year.

(e) If a debtor has agreed under a repayment or settlement agreement with the Secretary to pay costs associated with the collection of a debt at a specified amount or rate, the Secretary collects those costs in accordance with the agreement.

(f) The Secretary does not impose collection costs against State or local governments under paragraphs (a) through (d) of this section.

These regulations specify that the collection charges may be based on a weighted average of the contingent fees charged by collection agencies. They do not specify that collection charges may be based on the average of all costs associated with collecting defaulted loans, as opposed to the actual costs. The preamble of the final rule, as published in the Federal Register (Federal Register 57(244):60311-60312, December 18, 1992), indicated that a flat collection cost rate is permitted.

Section 682.410(b)(2)

Comment: Many commenters objected to the requirement that a guaranty agency must assess collection charges against the borrower. Other commenters stated that if collection charges had to be assessed, a flat rate should be used by each guaranty agency.

Discussion: The statute clearly specifies that, notwithstanding any provision of State law to the contrary, collection charges must be assessed against the borrower. See section 484A(b) of the Act. The formula referenced in 682.410(b)(2) specifies that the amount charged will be the lesser of the costs of collection under the formula in 34 CFR 30.60 or the amount the borrower would be charged if the loan was held by the Department. This amount will be a percentage of the principal and interest outstanding, may be calculated annually, and would be a flat rate assessed against all borrowers with defaulted loans held by that agency.

The Higher Education Reconciliation Act of 2005 (P.L. 109-171) amended section 428(c)(6)(B) of the Higher Education Act of 1965 [20 USC 1078(c)(6)(B)] to cap the amount of collection charges that may be added to the loan balance when a default loan is paid off through consolidation at 18.5% of the outstanding principal and interest. Similar language was added to section 428F(a)(1)(D) of the Higher Education Act of 1965 [20 USC 1078-6(a)(1)(D)] in connection with defaulted loans that were sold after rehabilitation.

The regulations at 34 CFR 674.45(e) specify that the collection charges on defaulted Perkins loans may be based on either actual or average costs. The regulations also specify the 30% (first collection attempt) and 40% (subsequent collection attempt) caps on the collection charges. These percentages are of the amounts applied to principal, interest and late charges. The corresponding percentages of the total payment are 23.1% and 28.6%, respectively. These regulations have been in effect since July 1, 2008. Before this date there were no caps on collection charges in the Perkins loan program, other than a cap on collection charges for defaulted Perkins loans repaid through rehabilitation. The regulations at 674.39(c)(1) cap collection charges at 24% on a loan repaid through rehabilitation (19.4% of the total amount paid). However, the promissory notes for many Perkins loans made from 1981 through 1986 limited collection costs to 25% of the outstanding principal and interest due on the loan.

Tools and Resources

FinAid provides two calculators relating to collection charges. The Loan Default Calculator shows the impact of collection charges on the repayment trajectory of the loan. For example, an unsubsidized Stafford loan that would normally take 10 years to repay will take 17 years with the same monthly payment after subtracting 20% collection charges from each payment. The Collection Cost Impact Chart shows similar results but for a range of loan terms.