Community college borrowers make up the largest share of student loan defaulters every year. This may be difficult to believe, given less than half of community college students borrow loans in the first place, and they tend to borrow less, on average, than their peers who enroll at other institutions. But 75 percent of community college students who borrow are low-income,[i] and about half either ending up taking a break in their education or dropping altogether.[ii] These factors are highly associated with default, thus making community college borrowers vulnerable to that outcome.

Default carries severe penalties that have substantial, long-term repercussions for borrowers, including a negative credit report record that lasts up to 7 years, a roughly 100 point hit to their credit score,[iii] non-stop interest accrual, collections fees totaling up to 25 percent of the defaulted balance,[iv] disqualification for additional federal financial aid, wage and tax refund garnishment, and account transfers that can cause significant confusion and delays in resolving the negative status. In some states, professional licenses are also denied to borrowers who default. And though defaults can be resolved, many borrowers are affected again and again, with about 40 percent of previously-defaulted borrowers experiencing another default within three years.[v]

Student loan default can also impose penalties on an institution. The federal government requires cohort default rates to fall below 30 percent, which means colleges must reach out to borrowers to counsel them on their loan repayment options. If colleges fail to stay below the CDR threshold, they lose out on all federal aid, including Pell Grants, which can spell financial ruin. Colleges also suffer from individual defaulters not being able to receive federal student aid they need to re-enroll, thus limiting local recruiting potential.

Default is a Relic of a Defunct Loan Program

In spite of the heavy consequences of default for borrowers and colleges, default is not logistically necessary. The status is a relic of the Federal Family Education Loan (FFEL) Program, under which the government paid banks to administer federal student loans. When a borrower defaulted, the government would buy back the debt from the bank and initiate a collections process. The FFEL program ended in 2010. Now that the federal government manages all aspects of lending under the Direct Loan Program, default and the transfer of delinquent loans to collection agencies is unnecessary.

In the current federal lending program, the distinction between delinquency and default is arbitrary. Currently, a borrower enters default after being delinquent on a loan payment for more than 270 days, and their loan is eventually transferred from a loan servicer to a collection agency. Collection agencies are responsible for administering the federal government’s extensive debt collection tools, such as garnishing a portion of a borrower’s wages or withholding tax refunds to satisfy debts. Collection agencies can also counsel borrowers to use programs that return their loan to regular repayment. However, there is no reason for collection agencies to have this role – servicers are capable of performing these functions., Thus, private collection agencies truly serve no purpose in the current system, and the designation of an account being “in default” is unnecessary.

Alternatives to Default

If default ends, there are still several steps the federal government can take to collect delinquent loans and help borrowers repay their debts without imposing the damaging consequences of the current system:

Perform collections within the regular repayment system.

Currently, borrowers face collections after 360 days of delinquency, when their loan is transferred from their servicer into the collections system. Without default, the federal government could still initiate collections at the same time but keep the loan in the regular repayment system without transferring to a private collection agency. Delinquency could still be reported to a credit bureau to ensure that there are consequences to non-payment. With this change, borrowers would avoid navigating complicated account transfers and paying the heavy fees currently associated with collections. This change would also allow the federal government to shift funds from the private collections agencies to loan servicers, ensuring that borrowers receive better counseling throughout the repayment process.

Replace collections with income-based repayment.

Default rules could also be amended so that low-income individuals don’t face collections. Instead, low-income defaulters could be automatically enrolled in a repayment plan based on their income, which can reduce their monthly payments to as little as $0, after a period of delinquency. For the many defaulters who have not yet earned a credential, they would remain eligible for federal financial aid, more easily be able to re-enroll in college, and eventually receive a credential and thus be better able to repay their debt.

The biggest beneficiaries of ending default would be community college students. Though there are several improvements that must be made to the federal loan system, ending default is an important first step to alleviating the strain on borrowers who are facing the worst consequences of borrowing. We know that the majority of defaulters don’t finish college – ending default would help them re-enroll, allowing them to truly benefit from the low-cost, high-quality education that community colleges provide.

Colleen Campbell is the Director, Postsecondary Education at the Center for American Progress. She can be reached at ccampbell@americanprogress.org.

[i] National Center for Education Statistics Powerstats table from Beginning Postsecondary Students, Table fkbmna1.

[ii] National Center for Education Statistics Powerstats table from Beginning Postsecondary Students, Table fkbmnf0.

[iii]https://www.urban.org/sites/default/files/publication/98884/underwater_on_student_debt_0.pdf

[iv]http://www.aei.org/wp-content/uploads/2018/08/Federal-Student-Loan-Defaults.pdf

[v]https://files.consumerfinance.gov/f/documents/201705_cfpb_Update-from-Student-Loan-Ombudsman-on-Redefaults.pdf