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By Suzanne Blake
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The Trump administration is moving toward bringing private debt collectors back into the federal student loan system.
As the administration looks to transfer defaulted federal student loan collections from the Department of Education to the Treasury Department, Treasury is slated to take responsibility for servicing federally held loans already in default through its Cross-Servicing Program. The program can use private contractors to collect delinquent federal debts.
“The administration's decision to bring back private debt collectors for federal student loans for the first time in more than six years could have serious financial consequences,” Alex Beene, a financial literacy instructor for the University of Tennessee at Martin, told Newsweek.
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However, Beene said the newly elected Democratic-controlled Congress could shake up the efforts.
“The administration argues that restarting collections will improve accountability and move borrowers back into repayment, but the incoming Congress could challenge that approach through legislation, although any major changes would still face the possibility of a presidential veto, leaving borrowers with uncertainty about how aggressively these collection efforts will ultimately be pursued,” Beene added.
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Why It Matters
More than 9 million borrowers are currently in default, collectively owing about $234 billion. If borrowers face wage garnishment and lost federal tax refunds, there could be far more on the line financially than just their student debt.
During the COVID-19 pandemic, student loan payments and most collection activity were suspended, and the Education Department canceled its contracts with private collection agencies.
The Education Department announced in January that it was delaying involuntary collections, including Administrative Wage Garnishment and the Treasury Offset Program while implementing changes to federal repayment programs.
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The Education Department and Treasury Department signed an agreement on March 19 for Treasury to take responsibility for servicing defaulted federally held federal student debt.
Treasury plans to integrate the Federal Student Aid Default Resolution Group with its existing Cross-Servicing Program.
“Debt collectors handling millions of federal student loans. What could possibly go wrong?” Michael Ryan, a personal finance expert and the founder of MichaelRyanMoney.com, told Newsweek.
This plan does not mean private debt collectors are taking over every federal student loan, but those in default could be impacted, and finance experts are already warning borrowers about the consequences.
“There is a massive potential conflict of interest here. A borrower who stays in default and continues making collection payments may generate more revenue for the debt collector than someone who rehabilitates their loan,” Kevin Thompson, the CEO of 9i Capital Group, told Newsweek. “So are we creating an incentive to keep borrowers in collections longer rather than getting them out of default?”
When Do Federal and Private Loans Enter Default?
For most federal student loans, default does not happen after one missed payment.
The current Federal Student Aid guidance says that if a borrower fails to make scheduled payments for at least 270 days, that’s when the federal loan enters default. Once that happens, most defaulted federal loans are transferred to the Education Department's Default Resolution Group.
“The defaulted loan portfolio has become gigantic, and they are looking to reduce administrative costs,” Thompson said. “I've always said this administration is emphasizing repayment, and moving defaulted loan collections to Treasury gives them access to additional financial systems and collection capabilities. Whether it works is another story.”
What Will Happen to Borrowers with Defaulted Loans?
Borrowers should not assume that collection agencies working with the federal government means their next paycheck or tax refund will automatically be seized.
According to Federal Student Aid, after at least 360 days without payment, borrowers who have not resolved their default can face involuntary collections. That can include wage garnishment of up to 15 percent of pay and Treasury offset, where the government can withhold a federal tax refund or other government payments.
However, borrowers must receive written notice before Treasury offset begins.
There are also ways to get out of default before or during the collection process.
Loan rehabilitation and loan consolidation are available. Borrowers may also repay a defaulted loan in full, although this is likely not practical for the majority of borrowers.
“For borrowers, I'd start by checking StudentAid.gov, confirming the balance and payment history, and looking at rehabilitation versus consolidation before agreeing to anything,” Ryan said. “Especially with all the servicing changes, I wouldn't automatically assume a collector's records are correct.”
While there could be new pushback from the Democratic-controlled Congress, that is unlikely to reverse the Trump administration’s decision.
“The incoming Democratic Congress can investigate the contracts and push for stronger protections, but it can't simply make existing federal debt disappear,” Ryan said. “And Trump's administration still controls how these programs are implemented within the law.”
Contact Newsweek editors on this story: Samantha Beech and Dave Siminoff.
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