Guaranteed Student Loans Lose Some Appeal
McCombs, Karen, ABA Banking Journal
The pendulum swings widely When it comes to banks' experience with guaranteed student loans. Some banks, caught in the grip of stringent collection regulations, have decided that guaranteed student loans are a hassle and have gotten out altogether. Others have spent millions upgrading their current in-house loan administration systems and hope the investment will pay off down the road. Most banks are somewhere in the middle, finding student loans not their most profitable investment, but not being hurt by what has remained a relatively dependable business.
Department of Education statistics show that overall student loan volume has increased 6% in the first quarter of 1991 from the same time last year, despite the $60 billion in outstanding loans. Nearly 10,000 institutions make the loans, including credit unions.
Guaranteed program. Through the guaranteed student loan program set up by the Higher Education Act of 1965, the government pays banks a 3.75% "special allowance" on guaranteed student loans. This supplements the rate hanks can charge for the loans--8% as of mid-March. The flat rate varies each quarter, "so other market forces won't unduly influence a lender's willingness to offer student loans," says Larry Oxendine, director of the department of policy and program development for the Department of Education's financial assistance program, which oversees all guaranteed student loans.
The rate is maintained at a slightly higher level than the rate on 91-day Treasury bills. Whether or not that is sufficient for the bank to make a profit depends on several factors, such as the bank's efficiency of loan administration.
Collection rules. In 1985, the Department of Education got fed up with what it perceived as irresponsibility on the part of lenders in getting delinquent borrowers to make good on their guaranteed student loans.
"Banks were getting their claims paid without making a diligent effort, which became an increased cost for the government to bear," says Oxendine. The Department of Education responded with due diligence requirements--specific steps that banks must take to collect on delinquent loans over a designated length of time--or else risk getting their claims rejected. Banks' due diligence is monitored by the state agencies that act as primary guarantors for guaranteed student loans.
But bankers say the requirements were a typically bureaucratic response.
"The whole program was poorly conceived," says Don Grigley, senior vice-president of Connecticut National Bank, Hartford, and chairman of ABA's consumer credit division. Grigley says the government did not adequately train lenders in collection procedures.
The regulations, which became effective in 1987, divide the guaranteed student loan collection procedure into 30-day increments over a six-month period. The lender is first required to notify the borrower through the mall that the loan is delinquent, then follow up with a combination of increasingly aggressive letters and phone calls.
After the final demand for payment has been made within the 151 to 180 days, the lender may file a claim for losses with its state guarantor. The claim must show documented proof that the required steps were taken to collect the funds. The Department has 100 reviewers for student loan programs that help 1,000 schools and guarantee agencies keep up to regulatory snuff.
Curing. The six-month series of intimidating correspondence is not banks' only option for trying to collect on guaranteed student loans. The government allows banks to "cure" the loan. If the lender can get the delinquent borrower to re-sign the agreement and make an initial payment, the slate is wiped clean and the loan is reinstated. Curing helps both the guarantor and the bank, because the bank receives payments and the guarantor is saved the trouble of filing its claim with the government.
The Department of Education introduced the cure option in March 1988 because many lenders had experienced difficulties interpreting due diligence procedures. …