CFPB Presses Congress to Change Bankruptcy Code

WASHINGTON — The Consumer Financial Protection Bureau is urging policymakers to reconsider how student loan debt is treated under the Bankruptcy Code.

In the agency's annual report on student loans, released Thursday, it said there are severe roadblocks for struggling student borrowers in getting modifications or other flexible options to help them pay off their debt.

As a result, the CFPB said Congress should revisit a 2005 change to the bankruptcy code that made most private student loan debt and other "qualified loans" exempt from discharge. The agency is also recommending more favorable tax treatment on any debt that is forgiven.

"Unlike mortgage servicing, there are no specific laws or rules that require specific procedures on loan modifications and the laws we administer," said Rohit Chopra, the CFPB's student loan ombudsman during a call with reporters Wednesday. "That is something that we are going to take a very close look at. . . . We are going to weigh every option to see that these problems are corrected."

The CFPB noted that the 2005 amendment, which raised the threshold to discharge student loan debt, made it easier for debt collection firms to increase recoveries on defaulted private student loans compared to other types of unsecured debt.

"While regulators and policymakers have continued to urge the private student loan industry to work constructively with borrowers on loan modifications, the 2005 changes to the bankruptcy code may be undermining these efforts," Chopra said. "These changes may be leading to higher expected post-default collections, reducing the incentive for lenders and servicers to modify loans and help borrowers avoid default even though it may be in the best interest of all parties over the long run."

The agency is also looking at whether it can create similar rules to what it applies to the mortgage market that require lenders and servicers to respond in a timely manner to struggling borrowers and use clearer disclosures. The CFPB made a similar recommendation in last year's report.

"In the mortgage market, servicers must contact delinquent borrowers about the delinquency and the possible availability of loss mitigation options. Servicers must also consider and respond to a borrower's application for a loan modification if it arrives before a certain period of time before a scheduled foreclosure sale," the report said. "If private student lenders and servicers are unable to overcome the challenges they face to offer and effectively communicate repayment options to borrowers in distress, the bureau may wish to study the effectiveness of the current disclosure framework implemented five years ago and determine whether additional disclosures and servicer obligations are warranted."

The CFPB looked at roughly 5,300 complaints received for the year ended Sept. 30. Based on those complaints, the agency found that: lenders were not clear and consistent with struggling borrowers on programs to help avoid default; lenders sometimes rebuffed borrowers who were seeking other repayment options; and forbearance options tended to be too short, typically lasting three months.

"Even with short-term forbearance options, consumers may experience unusual processing delays, unclear requirements, and unaffordable fees," the report said. Consumers "described an array of processing delays which then led to missed payments or default before the servicer approved or denied the application."

In last year's report, the CFPB identified issues with lenders and servicers processing private student loan payments. Since then, the CFPB said some lenders have self-corrected the issue.

"Some servicers notified the bureau that they have changed their payment allocation policies and now allocate payments from borrowers in excess of the scheduled payment amount toward the loan with the highest interest rate, absent alternative instructions," the study said. "Other industry participants noted that they plan to upgrade borrower-facing systems to allow borrowers to easily specify how they wish to allocate a payment across various loans."

Still, problems persist and new issues are popping up, Chopra said. Most recently, the CFPB has accused for-profit colleges Corinthian Colleges and ITT Educational Services of predatory lending.

"As we saw in the mortgage market, sloppy servicing can spawn scams. Fly-by-night foreclosure rescue schemes popped up when borrowers face problems with their mortgage service and now we are seeing a growth in student debt relief companies, some of whom are charging high fees but providing little in return," Chopra said. "This is something we're taking very seriously and we do not want to see a repeat of what happened in the mortgage market happen here."