Did the Department of Education Make Up a Legal Risk to Discourage Student Borrowers from Seeking Student Loan Discharges?

Early on in the Trump administration, Betsy DeVos’s Department of Education blocked an Obama-era regulation from going into effect that would overhaul how defrauded student loan borrowers could obtain debt relief.  A few weeks ago, the Department issued its own set of proposed rules that will make relief harder to obtain for hundreds of thousands of borrowers who were either misled by their schools or whose schools closed their doors.

These new changes were widely criticized by borrower advocates, who pointed out that many of the new rules were clearly aimed at protecting for-profit schools rather than average citizens.

However, one part in particular of the proposed rules leaped out at me.  The Department repeatedly claims that borrowers who obtained a closed school, false certification, or borrower defense discharge are at risk of having their official school transcripts withheld.

Withholding a transcript can have a devastating effect on already at-risk students.  A borrower may need that transcript to transfer to another school and finisher her degree, or prove to a potential employer that she’s completed the requisite coursework for a job.  Withholding a transcript can put a borrower’s life on hold and take away the promise that education offered in the first place.

The Department’s assertion that borrowers with discharged loans were at risk of having their transcript withheld came as news to me — and I research the issue of transcript withholding.  My paper on the topic will be presented at a higher education law conference this fall.

According to the Department’s notes,

The proposed regulations also would remind borrowers submitting affirmative or defensive claims that if the borrower receives a 100 percent discharge for the loan, the institution has the right to withhold an official transcript for the borrower, as has always been the case in instances in which the borrower has been awarded student loan discharge through false certification, closed school or defense to repayment discharge.

Sounds like this issue is pretty cut and dry to the Department: schools have always had the right to withhold an official transcript after a discharge.  However, the problem is that I cannot figure out where the Department is getting this assertion from.   And, despite no obvious evidence to back it up, this claim is being used by the Department to threaten scammed student borrowers, discouraging them from obtaining relief.

There are no rules or regulations about transcript withholding in the federal statutes or code of regulations.  Moreover, there is no mention of transcript withholding in the federal student loan master promissory notes, the contracts that govern the student loans that might later be subject to discharge.

Indeed, withholding a transcript has always been seen as a state law issue, one governed by the relationship between the student and the school, not the relationship between the student and the Department of Education.  Transcript withholding only occurs when a student defaults on a debt owed directly to the school such as unpaid library fees or a tuition bill that was never covered by student loans.

Does the Department of Education think that students will end up owing a debt directly to their school when they obtain a discharge on their student loans?  It’s true that the Department of Education is able to seek reimbursement for discharged student loans directly from the school.  For example, when ITT Tech went into bankruptcy, the Department of Education made a claim on the bankruptcy estate for more than $230 million to cover closed-school discharges and borrower defense discharges received by ITT Tech students.

In other words, does the Department of Education think that after paying back the Department of Education schools like ITT Tech have a corresponding claim against the individual borrowers—the ones whose student loans were discharged because of the school’s own closure?  If so, there are some obvious issues with this theory.

This supposed debt is unlikely to hold up in court.  Borrowers would have state unfair and deceptive acts and practices claims.  And equitable defenses would seem particularly appropriate.  When a student is relieved of her obligation to pay a student loan because of her school’s bad behavior, she cannot then be saddled in turn with a debt owed directly to that same school.

Alternately, what if the Department of Education is merely claiming that schools always have the ability to withhold official transcripts and they can choose to do so after a borrower obtains a discharge?  Again, this would be incorrect.

In 2009 the Seventh Circuit addressed a transcript withholding case after a student’s loans have been discharged in bankruptcy.  The Court held that “providing a transcript is an implicit part of the education contract” and that the student had a right to the transcript because, even though she hadn’t paid her school fees directly, the obligation to pay the debt had been discharged.  This case does depend on the state property law at issue, but it demonstrates that the Department of Education is misleading borrowers if this the grounds on which it claims that all schools have always had the right to withhold a transcript after a discharged student loan.

To be honest, I’m not entirely sure what the Department of Education was referring to when it claimed that schools could withhold transcripts after a borrower obtained a student loan discharge.  I have never heard of such a case happening and cannot think of a theoretical basis for it to be true.  Nevertheless, they repeat the assertion 5 times in the notice of proposed rulemaking.  At this point, I have to conclude that the Department is misleading the public to support their agenda of discouraging discharge applications.


Why Paying Your Student Loans Will Look Different in 2019

The federal government has put out a call for bids to radically overhaul the student loan servicing program in 2019 with the goal of creating a unified website to pay and administer all federal student loans.   Sounds great, right?  The question is whether they can pull it off.

Even though the Federal government owns most of the federal student loans issues since 2010, any student loan borrower knows they have to go to their servicer — Nelnet, Great Lakes, Navient, etc. — to actually pay their loans.

This web of servicers can cause numerous problems.  For instance, some servicers offer different amenities even though all loans should be handled in the same way.  Great Lakes makes it easy to apply extra payments towards principal through their web platform, whereas other servicers may require a follow-up phone call.

Moreover, if you’ve been trying to get Public Service Loan Forgiveness, you know that your loans will be transferred to FedLoan Servicing, no matter what servicer you started out with.  FedLoan Servicing is the most difficult servicer to work with.  One major issue I see is that the transfer of student loans to FedLoans kicks the borrower out of their repayment plan, capitalizing interest and causing numerous headaches.

The idea of merging together the platforms of all servicers under the umbrella of a single government website is certainly appealing.  But as with any technological endeavor from the federal government (looking at you, Healthcare.gov), actually pulling it off will be quite a feat.

As highlighted by the Center for American Progress, which has been doing excellent reporting on this issue, it’s unclear whether the new system will improve accountability for the servicers or whether it will merely be a new, unified branding on top of the same old problems.  Additionally, the Office of Federal Student Aid (FSA), which would be administering the new platform, has already said that it may need to bring on additional expertise to coordinate and manage the program.

Everything is in the early stages at this point and it will be interesting to see what happens as the bidding process goes forward.  Clearly FSA and the Department of Education can see that the system needs an overhaul.  The question is whether the cure will be worse than the disease.


Prosper Act, Part 2: Repayment Plans

As we discussed in Part 1, the Prosper Act is the biggest potential change to federal student loans in years.  The Prosper Act would create the Federal ONE loan program to replace the current Direct Loan program.  The Federal ONE program would drastically change the repayment plans available.

Currently Direct federal loans have a variety of repayment plans available — fixed and graduated balance-driven plans as well as a variety of income-driven plans like IBR, PAYE and REPAYE.

Under the Federal ONE program, there would be only 3 plans available:

  • The standard 10-year fixed repayment plan
  • One income-driven repayment plan
  • A fixed-rate repayment plan with an extended time after consolidation.

The Standard 10-year fixed repayment plan should be familiar to any federal borrower and is the backbone of the current repayment process.  Its terms are not changed under the Prosper Act.

However, the new income-driven plan has several substantial changes:

  • Borrowers would have to pay 15% of their discretionary income, an increase for many borrowers who qualify for current IDR plans that ask for 10% of their discretionary income.
  • The new minimum is $25/month, though this can be temporarily reduced to $5 under certain circumstances
  • There would be no forgiveness after 20 or 25 years, as currently exists under the IDR plans.  Instead, the balance would only be forgiven once the borrower had paid enough to cover the principal and interest the borrower would have paid if they’d entered the 10-year standard repayment plan
  • There is currently no public service loan forgiveness written into the plan

The extended fixed-rate repayment for consolidated loans allows for longer repayment terms under the following schedule.

< $7,500: 10 years
$7,500-$10,000: 12 years
$10,000-$20,000: 15 years
$20,000-$40,000: 20 years
$40,000-$60,000: 25 years
$60,000: 30 years

The decrease in options will certainly simplify the repayment landscape for Federal ONE loans. Notably it will not simplify the options for current Direct Loan borrowers who, as the bill is currently written, will be grandfathered into the Direct Loan plans. However, the more limited options remove affordable alternatives that decrease the cohort default rate.

Prosper Act, Part 1: Loan Programs

The biggest potential change to federal student loan policy in years, — The Prosper Act — is out of committee and could go up for a vote before the full House in the coming months.  This is Part 1 in a series of deep dives on the effect of the Prosper Act.  Today we will start with a summary of the new student loan program.

If you’re a devoted reader of this blog, or just a student loan wonk, you’ll know that there have been two major federal student loan programs: The Federal Family Education Loan (FFEL) Program and the Direct Loan Program.

Until the FFEL Program was sunsetted on July 1, 2010, the program provided for private lenders to issue federally-backed student loans.  Millions of dollars worth of FFEL loans are still on the books of borrowers all over the country.

Since 2010, most borrowers get their loans under the Direct Loan program, where the Department of Education funds and issues the loans rather than private lenders.

The Prosper Act would sunset the Direct Loan Program and replace it with the Federal ONE Loan Program.   

Since the Perkins program already expired in September 2017, Federal ONE Loan would be the main lending program if the Prosper Act passed.  Any new borrowers after June 30, 2019 would be issued Federal ONE loans, not Direct Loans.  Certain borrowers, such as those already enrolled in a program, would be grandfathered into Direct Loans until September 30, 2024 at the latest.

So what will a Federal ONE loan look like? It will be issued by the Department of Education — much like the Direct Loan — and will have similar interest rate caps based on the 10-year Treasury plus a spread.

The Federal ONE loan will impose annual caps on borrowing for graduate students and parents based on hard limits rather than the cost of attendance, which is currently used to create a cap under the Direct Loan program.  For instance, Parent loans will be capped at $12,500 annually rather than whatever is needed to meet the cost of attendance.

The biggest change will be in the repayment plans available.  We’ll cover that in the next post.