WASHINGTON — Federal student loan servicers could not market other products to borrowers and private student loans lacking certain protections could be discharged in bankruptcy under new recommendations unveiled Thursday by the Obama administration.
The proposed reforms by the Department of Education — the second announcement this week by policymakers seeking to assist student loan borrowers — would also change credit reporting to put federal loan borrowers who pay on time in better standing, and prohibit automatic defaults for private student loan borrowers when a cosigner dies or files for bankruptcy.
"Federal regulators have identified troubling practices in the private student loan market where borrowers who were current on their co-signed student loans were driven into default by their servicer due to actions outside of their control," the department said.
The report is part of intensifying efforts by the administration and the Consumer Financial Protection Bureau to put in place controls on skyrocketing college debt. President Obama called for reforms in March in his Student Aid Bill of Rights. And on Tuesday, the CFPB, DOE and Department of Treasury released a joint statement on principles for fixing student loan servicing problems.
"While we're proud of the historic steps we have taken to protect student loan borrowers, there's much more we all need to do," Secretary of Education Arne Duncan said in a press release.
He said "schools need to do more to keep" college affordable and "servicers owe borrowers better information about their options."
For federal student loans, the department called for "codifying" provisions used in contracts with servicers that ban the "marketing of other financial products to borrowers while they are in school or after they leave school." The prohibition would apply to phone calls, emails, web sites, mailings related to an account and automated interaction.
The recommendations also include a proposed reform that may make it easier for federal student loan servicers to contact borrowers in danger of default to inform them of different repayment plans. The law now bans servicers from auto-dialing borrowers using a cell phone number unless the borrower has explicitly consented, but the DOE called on Congress to lift that ban.
But the report also addressed possible reforms for outstanding private student loans as well. Those include steps to make it easier to discharge student loan debt in bankruptcy. Specifically, the department proposed allowing loans to be dischargeable if they do not include more generous repayment terms — known as "pay-as-you-earn" — that let borrowers pay the loan back as they earn income.
"Allowing private lenders the protection of non-dischargeability if they offer PAYE-like features will provide an incentive for private lenders to create meaningful ex ante payment modification options available for when borrowers cannot make standard payments," the report said.
However, getting such a reform through Congress would likely be an uphill battle. The 2005 bankruptcy reform law exempted most private student loan debt from being discharged. Last year, the CFPB urged lawmakers to ease that provision, and in March Sen. Richard Durbin, D-Ill., tried again to bring a bill to allow bankruptcy judges to cram down private student loan debt. But its chances are unlikely in the GOP-controlled Congress.
Yet the industry is downplaying the effects of loans on consumer financial problems tied to education costs. Richard Hunt, the chief executive of the Consumer Bankers Association, reiterated comments he made earlier in the week saying the cost of college tuition — not of credit — should be the focus of policymakers.
"With nearly 98 percent of private student loans being successfully repaid and tuition prices having risen 1,120% since 1978, we encourage the" DOE, Treasury, CFPB and Congress "to focus their attention on the root of the problem for students and borrowers, which is college affordability," he said in a press release Thursday.
Hunt said private student loan borrowers benefit from "a robust underwriting process that includes an ability-to-repay test."
"Private loans made by CBA members have a delinquency rate of less than 3 percent, the true test of successful lending and servicing," he said.
The DOE report also said private student loan borrowers who are current on their loans should not be hit with penalties if a cosigner dies or has to file for bankruptcy.
"In the most egregious cases, servicers placed current borrowers into default automatically because their co-signer died or filed for bankruptcy," the report said. "If borrowers are current, they should be able to remain in such a status without fear that their lender will drive them into financial ruin due to outside circumstances. The report recommends prohibiting certain practices, including requiring a borrower to pay in full if a co-signer dies or declares bankruptcy."