Dive Brief:

• Federal policymakers need to reform the student loan default system, according to an advocacy organization focused on affordability and equity in higher education.
• The government should let borrowers in default sign up for income-driven repayment, or IDR, plans, stop making borrowers pay their own collection costs, and exempt low-income borrowers from wage and federal benefit garnishments, according to The Institute for College Access & Success, or TICAS. 
• The organization released a memo this month that also highlighted policy changes that could help prevent defaults, such as automatically enrolling at-risk borrowers into an IDR plan and providing better data on which loan holders are struggling.

Dive Insight:

In response to the COVID-19 pandemic, all federal student loans have been paused since March 2020. The U.S. Department of Education suspended payments and stopped defaulted loan collections, while dropping loan interest rates to 0%. The relief program has been extended several times and is currently set to expire on May 1, 2022. 

One in four federal Direct Loan borrowers were in default at the end of 2019, according to a TICAS analysis of Ed Department data. A federal student loan defaults if the borrower misses payments for at least nine months. When the current relief program ends, borrowers in default will again immediately owe their entire unpaid loan balance plus interest from before the freeze, while likely being in worse economic shape than before the pandemic began.

It's especially difficult for borrowers because the government doesn't have to sue before garnishing someone's wages, something private institutions are required to do.

"It is financially devastating, even uniquely so, compared to regular consumer debt," said Jessica Thompson, vice president at TICAS. "The federal government can garnish your wages without a court judgment. It can offset your tax refund or offset your Social Security."

TICAS argued in its memo that the current default system is too punitive and often results in a vicious economic cycle for people who didn't have enough money to begin with.

Thompson said students who took on a few thousand dollars in debt but only completed a semester or two of college are an example. They may ignore their federal loans because the college credits they earned didn't significantly increase their earning potential, she said. By the time a borrower is in a position where they could start making payments, it can be too late.

"Your $5,000 loan is now $10,000, plus interest and fees. You can't get into income-driven repayment to start making payments based on your income because you're in default," she said. "You can't get any more financial aid. It's like all the tools that you would need to try to get back on track are suddenly unavailable to you."

If a student had to take out a federal loan to attend college, they are unlikely to reenroll and finish their degree without further financial assistance, said Thompson. This can pose a problem for college administrators looking to bring back students.

"Students are way less likely to successfully get back on a path to a degree or financial health if they're in default," Thompson said. "Colleges can make a significant difference with how they handle default management and by supporting their students to the completion of their programs."

The impending reinstatement of federal loan payments means now is the right time to talk about reforming the default system, according to Thompson. 

"Right now, we can't get people into IDR plans until they're out of default, which can take a long time," she said. "There's been a lot of talk about a possible fresh start." 

For example, the Ed Department could say borrowers in default have successfully met repayment requirements over the last two years, despite payments being paused. This would give loan holders a pathway out of default and into a repayment plan.

"We've seen that the federal student loan system can be flexible because it was literally put on hold for years," Thompson said. She hopes that can lead to change that will help borrowers.