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Inside the government's student loan problem

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Come January, dozens of private companies will bid to win lucrative government contracts to manage a chunk of the nation’s outstanding $1.3 trillion in federal student loan debt. At the forefront of that group will be Navient (NAVI), one of the four largest companies currently contracted by the government to service student loan debt for millions of borrowers. Navient, which already services more than $300 billion worth of student loan debt, was spun off from consumer banking giant Sallie Mae (SLM) a little over a year ago. It’s been plagued by legal troubles ever since, spurring consumer advocates and lawmakers to pressure the government to cancel the company’s contract. But so far the government hasn’t cut Navient. In fact, it renewed the company’s contract earlier this year. To understand why, Yahoo Finance took a deeper look inside the student loan servicing business.

Big bark, little bite

In June, $60 million worth of settlement checks were mailed out to active service members who federal officials claimed Navient had cheated out of interest-rate benefits. The payments were part of the $97 million settlement Navient reached with the Department of Justice a year ago. It’s also been at the center of a multistate probe led by attorneys general in Illinois and Washington. And another watchdog is now threatening to go after the company. In a filing with the Securities and Exchange Commission in August, Navient acknowledged that the Consumer Financial Protection Bureau is considering suing the company in the wake of an investigation into how Navient has administered late fees and “other matters.”

A CFPB spokesperson declined to comment on pending litigation, but the agency began seeking public comments on the student loan servicing business in May. In the past, inquiries like these have led to legal actions against mortgage servicers and credit card companies. Navient would be the first federal student loan servicer the agency has targeted. Whether or not the CFPB acts, Navient has already been soundly punished by Wall Street, with its shares sinking 42.4% this year. A Navient spokesperson says the company remains committed to focusing on its customers and believes its practices “meet or exceed standards” set by regulators.  

Despite legal troubles, however, Navient continues to benefit from its work with the government. The Department of Education renewed its contract with the company just a month after Navient settled the DOJ’s lawsuit, in which Navient CEO John Remondi admitted no wrongdoing but apologized for some "processing errors."  The DOE consented to perform an internal review of student loan servicers’ management of active-duty service members. But when the results were released in May, finding that servicers violated federal law in only 1% of cases, consumer advocates and lawmakers cried foul. Sen. Elizabeth Warren lobbied the Office of the Inspector General for the Department of Education to conduct its own review of the report, calling it “deeply flawed,” considering the DOJ’s claim that Navient charged 75,000 active duty service members excessive interest on their private and federal education loans. A spokesperson for the OIG confirmed they are “presently looking at the issue” but could not comment further.

The DOE’s report, coupled with the fact that it quickly renewed Navient’s contract despite the DOJ’s findings, left some questioning the ability of the agency to effectively regulate loan servicers — and officials’ willingness to cancel contracts when wrongdoings come to light. “It’s very disappointing to see the administration again awarding multimillion-dollar contracts to a company that has now been very obviously caught red-handed [violating federal law],” says Sarah Lewis, a senior policy researcher for the AFL-CIO. “The DOE needs to step up because in a lot of ways they can be putting borrowers in a more vulnerable place.”

Department of Education spokesperson Denise Horn defended the agency’s decision to renew Navient’s contract, saying it has since updated its contracts with all its student loan servicers, including Navient, to automatically award benefits like interest rate caps and public service loan forgiveness to active duty service members. “In its review of Navient’s actions, DOJ applied requirements that were different than those used by the Department,” Horn said in an email. “We have since updated our standards to be in line with those used by DOJ and we will be vigilant in ensuring that servicers are treating all student loan borrowers fairly – especially those who have sacrificed so much in service to our country.”

Broken system, bad incentives

The imperfect relationship between the government and student loan servicers like Navient has long been apparent. In March, the White House released a “Student Loan Bill of Rights,” giving the Department of Education until July 2016 to roll out a new student feedback system, where borrowers can file complaints against lenders, servicers and debt collectors. But critics say the problem isn’t the fact that borrowers have nowhere to sound off when they are mistreated. The CFPB has gathered tens of thousands of borrower complaints since it began accepting submissions in 2011. The DOE administers its own survey of customer feedback for each loan servicer it works with (that feedback score is used in part to determine how much loan debt the servicer is awarded in its contract). What’s missing, observers say, is assurance that when a student loan servicer is found to be violating borrower rights, the DOE will be willing to cut them loose.

“We need to have penalties that actually match the crime,” says Natalia Abrams, founder of Student Debt Crisis, a nonprofit advocacy group. “[Renewing Navient’s contract] doesn’t give me a lot of faith that they are fulfilling their duties.”

In defense of loan servicers, their main purpose isn’t to teach students how to better manage their loan debt, although customer service is the largest contributing factor the government considers when deciding how much loan debt they should be awarded. People tend to have complicated financial lives, and it takes time to come up with a personalized action plan for a specific borrower. Further complicating matters is the fact that loan service workers have to interpret three highly complicated income-based repayment plan options, meanwhile regulations on how each plan is to be administered are constantly being tweaked by lawmakers. The Obama administration is expected to roll out a fourth income-based repayment plan later this year, in fact.

Winfield Crigler, executive director of the Student Loan Servicing Alliance, which represents student loan servicers like Navient, says it’s unfair to place all of the blame of bad behavior on the servicers.

The DOE has yet to respond to a Yahoo Finance request for comment on how it penalizes loan servicers that are found to violate their contract. The Department did cancel a handful of contracts with private debt collection firms last February after finding that they had sent borrowers misleading information about their loans. One of the firms that got the boot was Navient-owned Pioneer Credit Recovery.

In a white paper published in 2014, Roland Zullo, a research scientist at the University of Michigan, who has studied the use of private loan contractors in the federal student loan market, argued that the current performance review system used to award contracts to student loan companies doesn’t do enough to disincentivize bad behavior. The servicers’ performance is based on several factors, including customer satisfaction (weighted most heavily as 35% of their overall score), percentage of borrowers current on their payments, and the percentage of borrowers who have fallen behind on payments. The way the rating system works, however, servicers are guaranteed some loans no matter how high or low they score. A low score simply means you will get a smaller piece of the pie.

Servicers are somewhat penalized when borrowers fall behind on payments, but not enough to make it financially worth their while to spend time working with struggling borrowers, Zullo says. For example, the DOE pays loan servicers a certain amount of money each month for the accounts they manage. For the first 3 million accounts, the maximum monthly payout is $2.85 for each account that’s current. That rate drops to 45 cents for accounts 270 days past due, a loss of $2.45 per account per month.

Edward Wolfe, 46, graduated law school in 2000 with more than $115,000 in federal student loan debt. He experienced several bouts of unemployment and enrolled in an income-based repayment plan in 2004. At the time, like most borrowers with student debt, his loans were serviced directly by the federal government through what was then called the Direct Loan program. After the DOE began outsourcing student loan servicing to private contractors in 2009, Wolfe’s loans were shifted to Sallie Mae and most recently, in 2014, to Navient. Wolfe had been enrolled in an income-driven repayment plan, which extends the repayment period and reduces payments to 10%-15% of income, for nearly a decade at that point. But a Navient representative said their records only went back as far as three years. Wolfe appealed to the DOE’s Ombudsman, who he says punted the question back to Navient. After more back and forth with Navient, he says he still isn’t sure the company has a complete record of his loan history. Under his income-driven repayment plan, Wolfe should be eligible to have his remaining loan balance forgiven after his 25-year repayment period is up. Losing records for six of the nine years he has been enrolled would be a major setback.

“The fact that I’ve been through this before with Navient and the fact that the DOE cannot or will not provide me with an answer is incredibly disturbing,” Wolfe says. “I want to believe these guys are keeping track of my records but they’re clearly not.” A Navient spokesperson says the firm does keep prior payment histories of all customers. The spokesperson did not comment on Wofle’s case specifically.

There’s plenty of evidence that points to inadequate customer service at loan servicers. In the six years since the government began contracting private loan servicers, complaints like Wolfe’s to the DOE’s Ombudsman more than doubled, from 17,000 in 2009 to 38,665 in 2014. The CFPB logged more than 13,000 student loan complaints of its own between 2012 and 2015, more than half of which pertain to trouble with loan servicers.

Many borrowers need extensive help figuring out how to manage their debt, especially if they are looking to consolidate, enroll in an income-driven repayment plan, or, in the case of active service members, take advantage of special repayment benefits like the interest rate cap Navient was caught mismanaging. “Any loan restructure requires time from a [loan] officer, which private firms are incentivized to limit,” Zullo says. “Loan servicing firms are fine for processing payments but neglectful when it comes to tailored services.”