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:
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.
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
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?
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.
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.
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