Eight Questions about Student Loan Default and "Fresh Start"

On April 6, the Department of Education (ED) announced a four-month extension of the current student loan payment pause—which also includes pauses on interest and collections—through August 31, 2022. Although the Biden administration had previously hinted that an extension was coming, there was also a larger announcement buried in the press release.

The administration plans to allow “all borrowers with paused loans to receive a ‘fresh start’ on repayment by eliminating the impact of delinquency and default and allowing them to reenter repayment in good standing.” Rumors of this fresh start trickled out last fall, but policymakers and advocates had long been thinking about and pushing the Department to bring borrowers out of default during the pandemic.

At the end of 2022, approximately one in six borrowers with federally managed student debt was in default. In the year before the pandemic, more than one million Direct Loan borrowers defaulted. Recent research indicates that borrowers of color, those with low incomes, those who don’t complete a degree, student parents, and first-generation students, among others, have particularly high rates of default. At the same time, these groups are more likely to have struggled during the pandemic. And even before COVID-19, many borrowers reported that financial insecurity was a major barrier to repayment.

Moving borrowers out of default will boost the financial security of close to eight million families

The current default system is like quicksand: It charges a host of confusing fees and offers limited pathways to exit, some of which can only be used once, meaning that borrowers can easily get stuck or cycle in and out. And the consequences of default—including collection fees; wage garnishment; withholding federal benefits and tax refunds, including the Earned Income Tax Credit and Child Tax Credit; and credit score damage—are overly punitive and felt more acutely by vulnerable communities.

Providing borrowers with a quick, manageable pathway to bring their loans back into good standing during the pandemic will bolster the financial security of the approximately eight million families with loans in default. Presumably, through fresh start, borrowers’ wages, tax refunds, and federal benefits will no longer be at risk of being garnished. And they will regain access to income-driven repayment (IDR) plans, Public Service Loan Forgiveness (PSLF), and federal financial aid if they want or need to return to school.

Fresh start will also put all borrowers affected by the pause on equal footing once repayment resumes. Borrowers who were not in default before the pandemic, including those who were severely delinquent on their loans, will exit the pause and be current on their loans. But before fresh start, borrowers in default—even if they were just a few days farther behind on their payments than those who were severely delinquent—would have exited the pause still in default.

And perhaps most importantly, fresh start lays the foundation for large-scale reforms to the student loan repayment system.

But there are few details about the Department's implementation plans

Advocates and policymakers have applauded this initiative at a high level, but ED has released little information about how it plans to move forward. In order to protect defaulted borrowers, ED must make sure they won’t be reentering a repayment system that did not serve them well the first time around. Below, I outline eight questions for ED as it begins implementation of this fresh start.

What pathway will ED use to allow borrowers to reenter repayment in good standing?

ED has used HEROES Act authority to extend the pause on student loan payments, interest, and collections during the pandemic. During the pause period, each month of suspended payments counts as a qualifying payment for loan forgiveness—such as for those enrolled in IDR or eligible for PSLF—and for rehabilitation. (Rehabilitation is one pathway through which borrowers can exit default.)

Through this authority, ED could allow additional borrowers to exit default during the pandemic emergency through rehabilitation. Borrowers can typically rehabilitate a loan only once, and when loans are rehabilitated, the default is resolved on a borrower’s credit report (although delinquencies—periods of missed payment leading up to a default—remain).

To use this pathway effectively, ED must waive the prohibition on using rehabilitation to exit default more than once, both to allow those who have already used it to do so again and ensure those who have not used it (but may need to do so in the future) maintain access. ED should also allow the rehabilitation period to be applied retroactively to the beginning of the national emergency in March 2020, giving borrowers the ability to count as many months of repayment as possible toward IDR and PSLF forgiveness.

Does “eliminating the impact of delinquency and default” mean that the borrowers will no longer experience any of the consequences of default? How will credit reporting agencies treat these loans in the short- and long-term?

Borrowers reentering good standing must immediately have access to some of the most important benefits and protections in the student loan system, including IDR, PSLF, and eligibility for federal financial aid. And credit reporting agencies must ensure that no borrower is worse off for having exited default.

How will ED manage such a seismic shift and allocate its limited resources?

The funding to pay for default-related expenses comes from a mandatory pot of money, but funding for servicing (for loans not in default) is discretionary and must be appropriated each year. If ED is removing borrowers from default, it must transfer them from the default system (the Debt Management and Collections System, or DMCS) to the repayment system. This means that close to eight million people would need to have their loans assigned to a student loan servicer.

To do so, ED would need to find discretionary dollars with which to pay servicers and decide which servicers would get the loans, a complex task when loans are already being transferred away from servicers leaving the system. (And recent reporting indicates that, without strong transparency and accountability, ED and servicers have mismanaged other initiatives and hurt borrowers in the process.)

As of October 2020, servicers were being paid a negotiated rate of $2.19 per borrower per month for loans in forbearance (i.e., paused) during the pandemic. Assuming this is still the case, without an additional appropriation, ED would be spending more than $15M per month out of its current funds. Once borrowers reenter repayment, if that rate increases to the $2.85 per month that servicers are typically paid for borrowers in good standing, ED will be faced with an even bigger monthly expense. Where would these additional funds come from and what would this mean for ED’s budget?

ED must ensure there is sufficient funding and appropriate staffing to protect and serve these vulnerable borrowers without affecting other resource-intensive initiatives it is currently undertaking, including standing up an enforcement unit, managing a robust negotiated rulemaking process, and dealing with the backlog of borrower defense claims, among others.

How will ED and servicers keep borrowers from redefaulting? Are there plans for fresh start-specific contractor oversight?

Even though ED recently instituted stronger performance metrics for servicers, as it implements fresh start, it must ensure that it puts in place additional monitoring and oversight for this specific initiative. (Again, ED has mismanaged oversight, not provided clear direction, and not mitigated risks of and actual servicer noncompliance in the past.)

Historically, rates of re-default have been high: In one study, more than 40 percent of borrowers who actively exited default through rehabilitation or consolidation defaulted again within five years. That number may be higher for those automatically removed from default. The Federal Reserve Bank of New York recently released an analysis (and there have been a host of surveys) indicating that borrowers may “face rising delinquencies once forbearance ends and payments resume.”

ED recently ended its contracts with private collection agencies (PCAs) who had been responsible for collecting on defaulted loans. While ED has been managing some outreach to borrowers, in January, the GAO published a report indicating that email addresses are missing for one-quarter of those in default. GAO noted that ED “is planning to reach these borrowers by using other outreach channels,” including social media. Now that these borrowers will be reentering repayment in good standing, what is ED’s longer-term plan for ensuring they avoid delinquency and default?

Transitions between the repayment and default systems have historically provided barriers to borrower success. However, those who are able to access an IDR plan after exiting default have much lower rates of delinquency and (re)default. Last fall, ED indicated that it was planning to allow borrowers to self-certify for IDR before and during the transition back to repayment. ED should provide the same flexibility now for borrowers exiting default.

ED must also determine the appropriate compensation for managing the accounts that will be exiting default to ensure that borrowers receive appropriate resources and servicers can engage in high-touch servicing where needed. Before the pandemic, PCAs were paid a fixed fee of $1,741 for each completed rehabilitation while servicers will be paid, at most, only $25 to service a loan that is returned to good standing via rehabilitation for a similar 9-month period.

How will fresh start intersect with other potential reforms?

The current student loan repayment system is complex, is confusing to borrowers, disproportionately negatively affects borrowers of color, and is likely unprepared for tens of millions to reenter repayment simultaneously after the period of paused payments ends. While the fresh start initiative will provide assistance for many with student loans, it is not a substitute for—and a host of advocates, researchers, and policymakers have called for—major, system-wide reforms, some of which ED has already started. These include efforts such as those that would:

• Make existing forgiveness programs—such as borrower defense to repayment, PSLF, closed-school discharge, and total and permanent disability discharges—work better for borrowers;
• Fix the IDR system, including lowering payments for struggling borrowers, addressing interest accrual and growing balances, reducing the length of time borrowers carry debt, removing administrative hurdles to enrollment and reenrollment, and providing a waiver similar to the one that expanded PSLF eligibility last fall; and
• Create simpler pathways out of default, create consistent terms for all borrowers, forgive debt for those who have been in default for an extended period of time, and limit collections.

In addition, ED recently announced that it plans to put out a new servicing solicitation and intends to do a rulemaking around debt collection this year, both of which give ED a chance to redesign default.

And finally, the White House has not made an announcement on whether it intends to further extend the payment pause or take action to cancel student debt.

What will happen with commercially-held Federal Family Education Loan program (FFEL) loans?

Different rules—via statutes, regulations, and administrative procedures—apply to Direct Loans vs. FFEL program loans and federal loans held by the Department vs. those that are held by commercial entities. Thus, the specifics of each program—and the roles, responsibilities, and funding of servicers, lenders, and guaranty agencies—differ. ED should consider these difference and ensure that fresh start applies in the same way to all defaulted borrowers.

While all borrowers in default have access to the payment pause, a sizable portion of the FFEL portfolio is still commercially-held (i.e., not held by ED). ED must consider what eliminating the impact of delinquency and default means for these borrowers and for guaranty agencies.

What are the implications of fresh start for ED’s Business Process Operations (BPO) contractors?

Recently, ED indicated that the BPOs would manage collection activities, among other tasks. ED must also consider how fresh start will affect their contracts and scopes of work.

Is five months enough to get all of this done?

The pause has been extended until the end of August, which is approximately five months away. Is that enough time to manage the complexity of the system writ large? Given the issues described above, it seems doubtful that ED, its contractors, and borrowers will be ready to restart repayment at the end of the summer.

An effort to eliminate the impact of delinquency and default and allow some of the most vulnerable borrowers to reenter repayment in good standing is an important step toward reforming student loan repayment. And moving such a major initiative through a federal bureaucracy is no small feat. But there are many details to work out to make sure borrowers are protected and served well by this transition, and there is much more to do to reform the system moving forward. Hopefully we will learn more soon.

This piece is adapted from previous work published by Brookings.

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