A reader sent me this excellent story of yet another nefarious lender practice, discovered by the Cleveland Plain Dealer. It works like this: once a student loan goes into default, lenders get up to 98% of their money back from the federal government (the guarantee in guaranteed loans). But instead lenders offload or "dump" the defaulted loan into the Direct Loan program by initiating Direct Loan Consolidation, pressuring the borrower to go along with it.
"the borrowers' bad debt, often multiplied because of earlier delinquencies and refinancing, gets turned into a new loan - with interest, late charges and an 18.5 percent handling fee for the industry. But this new, expensive loan is no longer the industry's liability; rather, industry employees convert it into a new government loan, issued under the federal Direct Loan program."
Let's see. So if you fall behind on your $40K loan, if lenders played by the rules they'd declare default after 9 months and collect, let's say, $38K plus interest--$45K?
Instead, they let it balloon to $100K with penalties and fees. Then they "dump" it into direct loan consolidation and take home $118K of taxpayer money.
This practice is costing taxpayers $400 million a year in fees and expenses for collection, which is often futile because the loan is already in default. It accounted for 46% of the industry's so called default "recoveries" last year.
These are the wonderful boons of competition between the direct and FFEL programs.