Can Student Loan Deferments Prevent Defaults?

To lower their number of student-loan defaults, colleges are embracing a controversial tactic: Encouraging borrowers to put off payments.

A growing number of nonprofit colleges are hiring companies that specialize in “default management” to reach out to former students who are behind on federal loan payments. These firms often recommend postponing payments through either deferment or forbearance.

One of these companies, Boston-based American Student Assistance, says 47 nonprofit schools have signed up or began contract negotiations for its default-prevention services over the past six months, bringing its total roster to 140 colleges. Student-loan servicer Edfinancial Services reports a 120% increase in nonprofit colleges signing up since last year, to 51 schools. And lender Sallie Mae says it has had a jump in colleges asking for help.

Recent data suggests that more borrowers are opting to delay payments, with or without default-management programs. Fifty-one percent of student loans were in deferment, forbearance or belonged to students still in school as of March 2012, up from 44.3% a year prior, according to data released by credit bureau TransUnion earlier this year.

Borrowers have to prove an economic hardship, like unemployment, to qualify for a postcollege deferment or forbearance. In deferment, interest is paid by the federal government for certain loans; in forbearance, the interest on all loans accrues in the borrower’s account.

Until recently, default management was mostly used by for-profit colleges trying to lower their high default rates. As student-loan debt woes have spread, nonprofit colleges are signing on. The reason: If a college’s federal student-loan default rate surpasses 25% for three consecutive years, or 40% in a single year, it could lose eligibility for federal student aid for all students, according to the Department of Education.

The companies say that they offer many services, including financial literacy programs for students, and that they inform borrowers about all repayment options—not just those that temporarily suspend payments. In most cases, the companies are compensated by the colleges, either with a flat fee or a rate based on the number of students they put into a program that helps keep them from defaulting.

Critics argue the strategy may help colleges at the expense of students. When borrowers return to paying these loans they often face a bigger balance than when they started, since interest on many federal loans continues to accrue. And delaying payment can force borrowers to stay in debt later into adulthood. Christine Lindstrom, higher education program director at the U.S. Public Interest Research Group, a nonprofit based in Washington, says what the colleges are doing is “a little unsavory.”

Colleges counter that while deferment helps keep their default rates down, it also gives borrowers time to find a job or income source to catch up on payments, while avoiding a default that can tarnish their credit.

Still, Congress has taken notice. Last month, a Senate bill was introduced calling for improved oversight of colleges engaging in default-rate manipulation.

Financial advisers recommend that students who are at risk of defaulting on their federal loans should first consider alternative options that won’t dig them into a deeper hole. That can include extended repayment, which stretches out the repayment period while lowering their monthly bill, or income-based repayment where borrowers repay their loans based on their income rather than how much they owe.


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