Student loan borrowers face breakdowns and delays in applying for repayment plans that feature loan forgiveness or interest subsidies, the Consumer Financial Protection Bureau said in a report released Monday.
The problems in two federal student loans programs could result in 200,000 struggling borrowers defaulting on their loans in the next two years despite being eligible for an income-drive repayment plan, the agency estimated.
Borrowers will end up paying $125 million in unnecessary interest charges over the next two years because servicers and debt collectors are not providing information on where to send payments, the amount to pay and how the payments will be applied to their loan balance, the report said.
Some borrowers report payment shock because servicers are billing them for hundreds of dollar more per month than what they had arranged with a debt collector to stay on track over the long term, the CFPB found.
"Too many student loan borrowers are being left behind due to breakdowns in the federal programs designed to provide them a fresh start, including an affordable monthly payment and a path to long-term success," said Seth Frotman, the CFPB's student loan ombudsman, in a press release.
Frotman sent letters to student loan servicers asking for information about how borrowers who have previously defaulted performed over time.
Borrowers can rehabilitate their debt by entering into an agreement with a debt collector to make a series of nine on-time monthly payments or they can refinance their default debt with a new direct consolidation loan.
The report claimed that incentives are misaligned because debt collectors have no "skin in the game." They are not encouraging the long-term success of borrowers.
Frotman urged policymakers to reform the misaligned incentives in the federal loan rehabilitation program that allow some debt collectors to earn $40 for every $1 in cash recovered from borrowers irrespective of the long-term performance of the loan.
Consumers with student loans have complained about every step of the process for getting out of default and into an income-drive repayment plan through their loan servicer, the CFPB said. Borrowers reported a broad range of servicing problems particularly for the five largest student loan servicers.
The CFPB estimated that more than 650,000 student loan borrowers rehabilitated a defaulted federal student loan by making $5 monthly payment for nine months. But 220,000 of those "will default a second time, unless policymakers and industry take immediate action," the report found.
"Today's report shows that far too many of these borrowers continue to fall through the cracks of a flawed student loan system," CFPB Director Richard Cordray said in the release. "The consumer protections promised under federal law should make it nearly impossible for the most vulnerable consumers to be trapped in default."