There is a perverse conflict of interest in the student loan business Read more: http://www.businessinsider.com/a-conflict-of-interest-in-the-student-loan-industry-2015-6#ixzz3dCshGaWd

Would you rather have $13 or $1,740? Easy question, right?

It’s no surprise that government contractors helping service and collect the Department of Education’s portfolio of student loans give the same answer you just did – the surprise is the perverse incentives the government has created to make this simple question negatively affect the finances and credit of millions of student loan holders attempting to start their careers.

The US Government now issues 93% of all student loans, and it holds a portfolio of more than $1 trillion in student loans. To “service” this portfolio of loans, the government contracts with 4 “TIVAS” (Title IV Additional Servicers) and 7 “NFPs” (Not-for Profit Servicers). These companies are paid $2.85 per month that a borrower is in current repayment, and between $1.05 and $2.11 for each month they are behind on payments or delaying paying loans due to educational hardship, illness, continuing education, residency, or military service. (full contract here)

When a borrower falls behind on their federal student loan payments, the servicers are mandated by their contracts to attempt to contact the borrower to help them resume repayment or restructure repayment to meet their economic situation. More than 3 million people are at least 30 days behind on their student loan payments and more than 7 million additional people are already in default, according to data released by the Department of Education. After 270 days of failing to make a payment, your federal student loan is considered to be in default, and it is passed to one of the businesses on the Department of Education’s “Default Management Collection Services” (DMCS) team.

Here’s where things go badly astray.

The DMCS providers receive $1,740 for each borrower in default that they get to resume paying their loan, or 2.75% of the total balance if the borrower consolidates to a new loan and resumes repaying (~$1,000 at the current average indebtedness) (full contract here). The DMCS providers also receive between 14% and 16% of the payments the person makes voluntarily or involuntarily through wage garnishment as they attempt to rehabilitate their loans. Last year, the government paid more than $500 million to these agencies to attempt to collect on the more than 7 million federal borrowers in default.

Two of the DMCS providers, Pioneer Credit Recovery and Premiere Credit of North America, are owned by servicers on the main government contract (Sallie Mae/Navient and Nelnet, respectively). So the holding company has a perverse incentive, obscured by contracts buried on government websites and separately named entities, to wait until a student loan holder is in default to really pursue repayment.

Instead of spending to improve communication to struggling borrowers or investing in new ways to service loans more effectively, these servicers have a strong economic incentive to do the minimum during the servicing period and let borrowers lapse into default, where the bounty is much more lucrative. Servicers earn a measly $13 in additional fees per borrower they successfully keep out of default, but their collection agencies can make more than $2,000 if they get the person repaying and rehabbed after they default. That fee is footed by the government (i.e. taxpayers) and then charged to the student’s loan balance, to put a struggling borrower even further away from getting out of debt.

Over the past five years, Premiere Credit has been paid $141 million by the Department of Education for debt collection services, and in 2013 & 2014, Pioneer Credit Recovery was paid $127 million to collect on federal debt. Pioneer has been removed from the federal default collections contract after finding they violated debt collection laws, but Premiere still collects on federal debt. This is simply an outrageous and unacceptable relationship.

Lawmakers and the media need to put more pressure on the Department of Education to eliminate these obvious conflicts of interest from its system. We must rework the compensation and competition in the servicing contracts to put a higher value on keeping borrowers current on their loans by explaining all the generous provisions in place to protect them if they are struggling to repay. Of all of the government’s servicers, care to guess which one had the highest current delinquency rate in the latest readings?

Pete Wylie is the co-founder of Gradible – the student loan destination. Gradible provides a free student loan evaluation tool that helps borrowers find, select and apply for the best possible repayment terms.

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