Education Secretary John King Jr. promised to hold student loan servicers accountable. (Susan Walsh/AP)

The Obama administration is taking a hard line on the contractors it uses to collect federal student loan payments, threatening to withhold compensation or new business if companies fail to adhere to new standards for servicing over a trillion dollars in student debt.

“When loan servicers make mistakes or don’t provide the right information at the right time, borrowers pay the price. Less than stellar student loan servicing is tripping up borrowers as they seek to climb the economic ladder,” Education Secretary John B. King Jr. said on a call with reporters Wednesday. “Borrowers deserve accurate, actionable and consistent information. The system must be fair and transparent, and servicers should be accountable to their borrowers.”

On Wednesday, the Department of Education issued guidance directing the head of its financial arm, James Runcie, to hold student loan servicers accountable for borrowers receiving accurate, consistent and timely information about their debt. The 56-page memo calls for the creation of financial incentives for targeted outreach to people at great risk of defaulting on their loans, a baseline level of service for all borrowers and a contract flexible enough to penalize servicers for poor service, among other things.

The department, working alongside the Department of Treasury and Consumer Financial Protection Bureau, wants routine audits of records, systems, complaints and a compliance-review process. Government agencies are also directing Runcie’s team to base compensation on response time to answering calls, completing applications for income-driven repayment plans, errors made during communications and the amount of time it takes to process payments. The recommendations will be adopted in the department’s new servicing contract slated to take effect at the end of the year.

“It’s a promising first step, but there is still a lot of work to do,” said Deanne Loonin, a consumer attorney who represents student debtors. “These policy directives still have to be incorporated into the servicing contracts. Also, so far, there is no clear way for borrowers to enforce these rights. We cannot rely only on the Department of Education to oversee the contracts and ensure that borrowers are protected. There must be rigorous public and private enforcement.”

Companies such as Navient, Great Lakes and American Education Services are paid hundreds of millions of dollars by the federal government to not only handle payments, but also answer questions and help people avoid defaulting on their loans. Critics question whether these servicers are doing enough as 7.9 million people had not made a payment on $121 billion in student loans for at least nine months at the end of March, a nearly 8 percent increase over the same period a year earlier. While more than half of the people in default have loans from the old bank-based federal lending program, the number of borrowers with newer loans falling behind on payments is inching up.

Researchers at the Government Accountability Office found that 70 percent of people in default actually qualified for a lower monthly payment through income-driven plans that cap monthly payments to a percentage of earnings, but servicers are failing to provide sufficient information about the options. Even when the contractors reach out to delinquent borrowers, the information is often inconsistent.

Those findings mirror the thousands of complaints the CFPB has received about servicers providing inconsistent information, misplacing their paperwork or charging unexpected fees. These are the same sort of problems that occurred in mortgage servicing and that led to consumer protection reforms in that space.

“We understand that from this experience [in the housing market] that servicing is not a one-size-fits-all process, and similarly we’ve learned that placing student loan borrowers in an inappropriate and unsustainable repayment plan can sometimes happen,” Treasury Deputy Secretary Sarah Bloom Raskin said on the call. “Servicers must do a substantial amount of engagement with a student loan borrower to find the option that best meets the borrower’s needs before they become delinquent or enter default.”

Servicers have argued that they deploy all of their resources to catch borrowers before they default, but all of the mailers, calls and emails often go ignored. And until now, there have been no market-wide federal rules for how servicers are supposed to operate.

“We welcome clear and coordinated industry-wide guidance on servicing standards,” said Navient spokeswoman Patricia Nash Christel, in an email. “We’re also pleased to see several themes that reflect opportunities we’ve identified, such as coordination across agencies to identify military members eligible for hostile pay benefits and streamlined methods for income-driven enrollment.”

Wednesday’s announcement arrives a year after President Obama signed a presidential memorandum, called the Student Aid Bill of Rights, directing federal agencies to overhaul the way Americans repay their student loans. The new standards dovetails with efforts to strengthen loan servicing, including the CFPB’s “Payback Playbook,” a guide to help borrowers determine the best repayment plans for them. The Education Department is also completing a central point of access for all people repaying their federal student loans to check their accounts and track their payments, rather than leaving it up to each individual servicer to furnish that information.

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