The Education Department's (ED) office of Federal Student Aid (FSA), which oversees the government's massive student loan portfolio, is launching stronger standards for student loan servicers in an effort to tighten oversight.
“FSA is raising the bar for the level of service student loan borrowers will receive," FSA Chief Operating Officer Richard Cordray said in a statement.
As payments are set to resume on January 31, 2022, the agency's moves — which follow on the back of recent news of a new Office of Enforcement that it's setting up — “come at a critical time," added Cordray, and "enables us to ensure that loan servicers meet the tougher standards or face consequences.”
'Revolution in servicing'
FSA, which handles more than a trillion dollars in federal student loans, has a lot on its plate as the payment pause looms in early 2022. More than 16 million borrowers need a new loan servicer, and the stakes to get the machinery working efficiently are high.
The standards introduced on Friday address some of the core concerns many advocates have had in the past: the performance of loan servicers, introduction of more transparency, as well as the increase in accountability measures for the six student loan servicing companies that are in the system.
The companies affected by the news include Great Lakes, HESC/Edfinancial, MOHELA, Navient, Nelnet, and OSLA Servicing. FSA has extended their contracts for two years.
FedLoan Servicing (PHEAA) and Granite State, who are no longer in the servicing game, will have their accounts transferred to the remaining six. Navient is in the process of transferring its contract to Maximus, another servicer.
The standards will kick into effect early next year.
"This is a revolution in servicing," Cordray, who previously served as the Consumer Financial Protection Bureau Director under President Barack Obama, said in an exclusive interview with Yahoo Finance on Friday.
"Up to now, the servicers ... had a general role, and they kind of carried it out as they pleased," he said. "We have decided that we need to make sure that they understand our goals and that means putting borrowers first ... and I believe that reflects a major change in the program. We will see how it works over time. And if we need to refine it, we will."
Performance standards come with penalties and rewards
All of the servicers' contracts were set to expire at the end of the year, and were extended by two years after FSA negotiated new terms — which involved two months of back and forth, Cordray said. He further acknowledged that the new terms may have factored into the exit decisions by PHEAA and Granite State.
The new terms give FSA increased ability to monitor and address issues in servicing as they arise, require compliance with federal, state and local laws related to loan servicing, and introduce carrots and sticks into the process for loan servicers.
That means if a servicer performs poorly, FSA can withhold new loans and associated revenue. If they perform well, they'll get more loan volume.
"Student loan servicers will now have strong financial incentives to provide quality service to their customers," ED's press release stated.
The servicers will be measured every quarter by the following:
Percentage of borrowers who end a call before reaching a customer service representative by phone;
How well customer service representatives answer borrower questions and help them navigate repayment options;
Whether servicers process borrower requests accurately the first time;
And the overall level of customer service provided to borrowers.
FSA is also requiring servicers to beef up call center hours and increase the number of workers who speak Spanish.
"The percentage of new borrower accounts, which is revenue that you're going to get, is going to be tied to how well you score," a senior FSA official told Yahoo Finance. The agency wants "to have an element that had real accountability attached to it... real rewards for delivering on that borrower experience, and real penalties for not."
The new contracts also bring more transparency into the system, by requiring loan servicers to provide comprehensive reports on borrowers’ experiences, such as how long it takes for a servicer to process an application, which applications are denied, and complaints logged most often by borrowers.
Under the new contract terms, FSA can also publicly release servicers' performance data.
“These new contracts send a clear message: the days of student loan servicers getting away with abusive behavior and abysmal customer service are over," U.S. Senator Elizabeth Warren said in a statement to Yahoo Finance. "I look forward to working with Secretary Cardona and Richard Cordray to hold servicers accountable.”
FSA staffing concerns
With two new initiatives in two weeks, there is a question of whether FSA has enough warm bodies to execute some of its plans.
According to a recent Government Accountability Office report in August, while FSA's Direct Loan volume increased by around 450%, and the number of borrowers it looks after increased by nearly 150% from 2010 to 2019, its staff only increased by 6%.
Cordray acknowledged the staffing crunch, and said that he was working with the Office of Management and Budget (OMB) on that issue.
"The announcement of the Office of Enforcement ... will involve some staffing up, and we're trying to work through the budget process right now with OMB and others to make sure they fully appreciate the need for that and why that's important," said Cordray. "We're trying to work out some of the details of that."
Aarthi is a reporter for Yahoo Finance. She can be reached at email@example.com. Follow her on Twitter @aarthiswami.