Evolving the Student Loan Guarantor: A Borrower-Centric Model

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1 Evolving the Student Loan Guarantor: A Borrower-Centric Model Ensuring Student Loan Borrower s Consumer Rights The U.S. s federal student loan programs have reached a tipping point. For over 15 years, Congress, colleges, and the higher education financing industry in general have been locked in an often fierce and polarizing struggle between the Federal Family Education Loan and Direct Loan programs. The major focus of the debate to date has been which program scores less in the federal budget. The present economic crises, coupled with recent changes in legislation, threaten to end this debate, not through the strength of reason, but through default. While emergency legislation has temporarily ensured the availability of FFEL loans using private capital, the continuation of that program is seriously threatened. We have not chosen the DL program, we are left with it. The current crises, coupled with the new leadership in Washington DC, have given the student loan industry, higher education community and policymakers a rare opportunity to make real change happen in federal student loans. Rather than settling for the last program standing, now is the time to re-create the federal program so that it is both cost-effective for taxpayers and consumer -focused. Too often the student loan borrower is seen as merely a recipient of financial aid, and not as a consumer. But unlike grant aid, the long term nature of the loans, as well as the obligations and relationships created by it over the life of the loan, make the education borrower, in every sense, a consumer rather than just a recipient. And for the consumer, today s issue is the debt. There is a growing public awareness of the economic and social impact on borrowers who have to manage

2 education debt while beginning a career, starting a family, and planning their economic future. Of course, there are inherent differences between education debt and consumer debt. While we could feel less compassionate toward a borrower who racked up credit card debt or bought more house than they could really afford, student loan debt is different, in that it s taxpayer-insured against default and the interest is subsidized in certain cases. Most importantly, student loan debt differs because it is a direct result of public policy. The borrower is awarded the debt to access higher education, improve his life, and become a more productive, well educated part of our labor force. For the borrower, we acknowledge the different nature of federal student loan debt by making it non-dischargeable in bankruptcy, meaning that the borrower has a higher "moral" obligation to repay this debt over other consumer debts. It is a lifetime obligation. But if the different nature of this debt makes education loan borrowers consumers with extra obligations, then it also makes them consumers with extra rights. Over and above the normal consumer rights of choice, effective competition, and clear and honest information, these consumers have an extra right, a right to effective debt management and default prevention services over the life of the loan. After all, if the federal government helped students get into debt, it also has an obligation to help them successfully get out of debt. Additionally, many student loan borrowers are also consumers with extra needs, since the traditional 18- to 24-year-old student is not equipped to make the same informed decisions as more mature consumers. A truly borrower-centric federal student loan program, therefore, must contain adequate consumer protections and mechanisms.

3 American Student Assistance believes the best way to incorporate these critical support services for students into the federal student loan program, regardless of its ultimate shape, is to evolve the role of the guarantor independent, federally funded, nonprofit organizations with 50-plus years of experience in higher education finance and a proven track record in positively affecting student loan repayment. We call for the primary role of the guarantor to move from administering the federal insurance for lenders and acting as a default collector, to instead guaranteeing that all federal student loan borrowers, regardless of the source of loan capital, receive high quality, independent, and unbiased life-of-theloan support services to help assure a successful higher education experience and promote fiscal responsibility. An Evolving Role for the Guarantor In the existing programs today there are limited life-of-the-loan support systems for borrowers. Financial aid officers are able to provide some degree of assistance, but are frequently under considerable demands to meet the needs of hundreds of students at a time, let alone alumni who have left campus. Lenders do provide general financial literacy information but it is limited, often too general to be helpful, and, in the case of specific repayment remedies, the solutions offered by the lender or its hired servicer can never be truly neutral, as the owner of the loan has a vested interest in the loan as an asset in its portfolio. Debt management and financial literacy services are provided by guarantors, but these services are not provided universally, and students participating in the Direct Lending program have no access to guarantor-provided financial literacy services at all. We envision an evolved role for the guarantor as neutral third-party (uncomplicated by any ownership in the loan) providers of support for all borrowers over the life of the loan. A new borrower-centric guarantor will make it much easier for students and families to navigate the student loan process from application to payment and make informed decisions throughout their entire loan experience. The role and

4 financing of guarantors would be refocused away from origination and default collection, and instead move toward providing: (1) overall program administration and support; (2) consumer information in the community; (3) early awareness and financial literacy information for students and parents; (4) counseling for borrowers on loan repayment plans to avert delinquency and default; and (5) loan rehabilitation. Overall program administration and support. Guarantors would continue to assist the government in administering the federal student loan program locally, at the state or regional level, serving as a resource to participants for interpreting federal regulations and carrying out any oversight activities, including partnering with the Department of Education on program reviews of participating institutions of higher education in accordance with regulatory guidance or directives. Guarantors would provide in-person training and assistance to schools and financial aid officers. Consumer information for the community. Guarantors would continue to help college loan consumers in the communities they serve make informed decisions regarding higher education financing. They would provide quality information and advice on financial aid, student loans and financial literacy through student and family outreach, publications and internet assistance. Guarantors would also leverage the significant partnerships they ve formed with college planning professionals at the state level to expand and refine their information services to the needs of the consumers within their respective footprints. Early awareness and financial literacy. Guarantors would partner with higher education institutions and loan originators to provide students and families with early awareness leading up to the student loan application process, as well as financial literacy information during and after the in-school period. Guarantors would assist with entrance and exit student loan counseling to borrowers, as well as take advantage of the entire student loan process as a teachable moment to instill

5 better money management skills in all students. Additionally, since early withdrawal is a key risk factor in student loan default, guarantors would play a role in providing or advising on persistence and completion programs; Debt counseling to prevent default and ensure financial wellness. Guarantors would assist borrowers in selecting a loan repayment plan and in applying for any loan cancellation, forgiveness, deferment, forbearance, or repayment benefits to which they are entitled. This form of counseling, which would be proactive and use the most up-to-date communication methods, would go far beyond the due diligence requirements currently outlined in the federal regulations. It instead would be customized and individualized to the borrower, helping them to fully understand all of the repayment opportunities and remedies made available to them by Congress. Such a comprehensive approach to education debt counseling would not only avert delinquency and default, but also recognize the important role student loan payment plays in a borrower s overall financial health. Loan rehabilitation. Guarantors would work with defaulted borrowers toward rehabilitation, the process whereby a borrower can make a specified number of consecutive on-time payments to bring the loan back into good standing. Guarantors would attempt to provide rehabilitation to defaulted borrowers for a specific, pre-determined amount of time before transferring the loan to the government for default collection.

6 Guarantor Financing and Borrower Assignments Under the current guaranty agency funding model, guarantors receive more monetary compensation for defaulted loan collection than default prevention. More than 60 percent of their revenues are derived from the collection of defaulted student loans. This finance model suited the guarantor s original purpose, which was to insure lenders against default and manage the government s defaulted student loan portfolio. Over the past 20 years, though, as the student loan industry moved to a default prevention mindset, the legislation that governed guarantor financing lagged behind. Legislative steps were taken to encourage default prevention, but only in piecemeal, through such vehicles as risk sharing, whereby guarantors assume part of the financial responsibility for default claims to lenders, and the 1 percent Default Aversion Fee on all new loans to be held by guarantors to cover cases of default. We believe that Congress should finish the job it s started: A new guarantor finance model, one more aligned with the guarantor s public purpose and consumer focus, should be part of the reformed federal student loan program. A more effective model for guarantors is one where they are rewarded for helping students stay in good standing. Adjusting the guarantor payment system to a Default Prevention, fee-for-service basis would emphasize appropriate debt management, keeping borrowers in repayment, and rehabilitation, rather than a collections-based approach. Under this structure, the guarantor financial incentive would be to maintain each borrower in good standing. Finally, regarding borrower assignment to guarantor, every institution of higher education that receives federal aid would have the freedom, at no cost to the institution or its students, to choose a guarantor from which it shall receive student and college support services. Each borrower would also have the freedom to select his/her guarantor, irrespective of state designation or selection by an institution of higher education.

7 Conclusion The new role of the guarantor we envision would provide a single point of contact for borrowers, prospective borrowers, families, schools, and related third parties to assist in the proper administration and support of the federal student loan program(s). But most importantly, under this proposal, the borrower-centric guarantor would ensure students everywhere equal access to their consumer right to education debt management. In closing, it is worth noting that the federal student loan program has taken 40- plus years to germinate. Along the way, it has grown into an admittedly complex and intricate program that only a select few in Congress and the higher education finance industry fully understand. Therefore, the process of program deconstruction, and then reconstruction, must be carried out thoughtfully and in a timeframe that allows for healthy debate. This proposal outlines one of the myriad of scenarios that could be incorporated into our nation s student loan system. We hope that it provides food for thought as policymakers, the higher education community and the student loan industry begin the process of building the ideal federal student loan program. For more information, visit