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The college loan system's fatal flaw

When you take out a mortgage or get a new credit card, you receive disclosures on the costs and risks of your transaction.

That’s often not the case with student loans, which can end up costing you up to six figures the rest of your life. The lack of clear disclosure and counseling in high school and college is why more than 43 million Americans carry some $1.4 trillion of this debt, which is nearly impossible to discharge in bankruptcy. College loans are the second-largest consumer debt after mortgages.

A lack of clear, upfront consumer protection on these loans is a prime reason millions of Americans are facing needless economic hardship. In an untold number of cases, borrowers were simply not walked through what their loans would cost over time.

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The fatal flaw in the loan application process -- at least for students -- was illuminated in two recent suits Consumer Financial Protection Bureau (CFPB) and the Illinois attorney general filed against Navient and two subsidiaries. Navient, which has denied wrongdoing, is the largest U.S. college loan servicing company and administers more than $300 billion in federal and private loans on more than 12 million accounts. It separated from loan company Sallie Mae in 2014. 

In the CFPB complaint, filed on Jan. 18, the government alleges Navient created  “obstacles to repayment by providing bad information, processing payments incorrectly, and failing to act when borrowers complained. Through shortcuts and deception, the company also illegally cheated many struggling borrowers out of their rights to lower repayments, which caused them to pay much more than they had to for their loans.”

“For years, Navient failed consumers who counted on the company to help give them a fair chance to pay back their student loans,” said CFPB Director Richard Cordray in a statement. “At every stage of repayment, Navient chose to shortcut and deceive consumers to save on operating costs. Too many borrowers paid more for their loans because Navient illegally cheated them, and today’s action seeks to hold them accountable.”  

Companies like Navient act as gatekeepers between students/graduates and the government and private lenders. These loan servicers were supposed to tell borrowers the cheapest ways to handle repayments. In many cases, though, they may have placed students in the most expensive loans or neglected to tell them they could qualify for lower-cost consolidation and income-based repayment plans through a federal program.

Illinois Attorney General Lisa Madigan zeroed in on the core problem with the college loan system and its troubled relationship with lenders and servicers: Servicers are definitely not acting as guidance counselors to steer borrowers to the best decisions. The companies also had financial incentives designed to make borrowers pay more in interest and total payments.

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Madigan alleged “Navient failed to perform its core duties. Struggling borrowers in Illinois and nationwide complain that Navient consistently failed to assist borrowers.”

Digging deeper into the suits, you can find egregious abuses of students that echo the subprime loan crisis that fed the 2008 financial crisis.

Not only is Navient accused of failing to present money-saving options in the federal program, it allegedly placed borrowers in high-cost loans, then followed up with aggressive debt collection when borrowers failed to repay. 

“In spite of encouraging borrowers to call Navient for help when they were struggling to pay their loans,” Madigan alleged, “Navient repeatedly failed to tell those borrowers about affordable repayment plans that were available to them.”  

For example, one unnamed student at Chicago-based, for-profit cooking school Le Cordon Bleu was told by the school’s financial aid representative to apply for a variable-interest rate Sallie Mae (Navient’s former parent company) loan that charged 17 percent annually at the time. Combined with a federal loan, the student was paying more $11,000 a year on her debt upon graduation. 

In desperation and unable to reduce her loan payments to an affordable level through Navient, she wrote to the Illinois attorney general’s office: “I don’t know that anything can be done. I have signed a contract, but not without hope. I can’t stress enough, I want to pay back my loans. Do you have any guidance? Do I have any recourse?” 

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Borrowers actually have several options. 

With private loans, you can attempt to negotiate with the lender or refinance them through a third party such as SoFi or Credible.com. There are a few catches, however. You’ll be subject to credit and employment checks. The best rates will go to those working with a solid credit history. 

A federal government program offers a number of repayment options that are linked to your current and future earnings. You can reduce your payment if you qualify, although a thicket of regulations govern each option. It gets complicated if you’re in default. 

While the CFPB and Illinois actions are steps in the right direction, they miss the draconian shortcoming of the college financing system.

Colleges, high schools and the U.S. Department of Education should be doing comprehensive counseling in school on understanding the negative impact of borrowing. This is at least as important as driver’s education and other key personal finance issues. The earlier students and families receive the basics on the full costs of loans, the better.