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The Fall of Consumer Protections for Student Loans

In the 1970's, Congress began to remove standard consumer protections from student loans at the urgings of industry. Entities including Sallie Mae, USA Funds,(which was to be purchased by Sallie Mae in 1999), The Consumer Banker's Association, and others engaged in a deliberate long term strategy to make student loans inescapable, hugely profitable through not only loan payments, but also late fees, and default penalties. This campaign culminated in watershed legislation in 1998 that made student loans not only risk free, but also far more profitable when students defaulted on their loans.

However, the campaign did not end there. By 2006, student loans had become the most absent of consumer protections of any type of loan instrument in the nation's history.


While no one ever wants to file for bankruptcy, the reasons for bankruptcy protections are well founded. Bankruptcy protection affords citizens with insurmountable debt a legal mechanism for resolving their debts, and continuing on to be productive citizens. This is seen by most as a critically important freedom to have, and serves as a protection against human rights abuses that frequently occurred for debtors in centuries past, including slavery, involuntary servitude, and debtor's prison. Bankruptcy protections are also seen as a critical freedom for a nation to provide its citizens in order to encourage and foster entrepreneurship, risk taking, and creativity. For example, notable Americans including Thomas Jefferson and Henry Ford.

The rationale for the restriction, and ultimately, the removal of bankruptcy protections for federally guaranteed student loans was predicated largely on anecdotal examples- promulgated by the lending industry- of students who filed for bankruptcy upon graduation. Instances of this type of activity were reported widely in the media, and in 1978, Congress put a 7 year repayment condition on dischargeability of student loans in bankruptcy. The amendments to the HEA in 1998 went much further, and took bankruptcy protection away completely for the vast majority of borrowers.

Interestingly, the language that exempted student loans from bankruptcy discharge in the 1978 overhaul of bankruptcy laws- which reportedly came up "at the last minute" was opposed by both the primary co-sponsor of the bill, Rep. Don Edwards, and the Chairman of the House Subcommittee on Postsecondary Education, Rep. James O'Hara. Edwards' opposition was strong. He said that Congress was "Fighting a 'scandal' which exists primarily in the imagination."

The statistics on bankruptcy filings, moreover, painted a far different picture from the one used as a premise for removing bankruptcy protections from student loans. People graduating from college, and then promptly filing for bankruptcy protections for the sole purpose of erasing student loan debt simply did not occur in numbers large enough to warrant such draconian legislation. In fact, it was shown by the Government Accountability Office that prior to the 1978 legislation, fewer than 1% of federally guaranteed student loans were discharged in Bankruptcy proceedings. Thus, the initial basis for the removal of bankruptcy protections is highly suspect, and evidently without firm grounding in fact.

Another rationale given for the removal of bankruptcy protections for student loans is the fact that the federal government guarantees these loans. However, there is no precedent for this. There are no other federal loan guarantees in existence in the United States- secured or unsecured- that enjoy bankruptcy exemptions. From Farm Loans, to FEMA Loans, to SBA Loans, and all other government loans, and government loan guarantees, not a single one- with the exception of student loans- enjoy exemptions from bankruptcy discharge.

For private student loans, the lending industry argued that removal of bankruptcy protections would allow for greater accessibility of student loans to individuals with lower credit scores by allowing the lenders to loosen the underwriting criteria. Two years after the removal by Congress of bankruptcy protections for private loans, however, no evidence could be found to show that the lenders followed through with their promise, based on disclosures by the largest private lenders. A study performed by Mark Kantrowitz, of Finaid.Org, found that since the removal of bankruptcy protections for private loans in 2005, the percentage of borrowers with low credit scores receiving private loans from Sallie Mae, for instance, increased by a mere 0.2% .


From the beginning of the federally guaranteed student loan program, there was no obvious mechanism for the refinancing of student loans after graduation and consolidation of the loans. In other words, once a student graduated and consolidated his or her loans, that borrower could never leave that lender, even if there were lenders who were willing to offer better terms.

This consumer protection is taken for granted in every other lending industry, but was non-existent for student loans until an enterprising student loan executive at a small student loan company found a loophole in federal law whereby a borrower could indeed, transfer his/her loans through the Direct Lending program, and back out to the FFELP program with a different lender.. This process, known as the "two step" (and later evolving into the "super two step") allowed borrowers who had consolidated their loans at high interest rates to move their loan to a different lender offering better rates.

While the Department of Education initially "gave the blessing" to this process, whereby borrowers could legally refinance their student loan debt, Sallie Mae and Citibank did not want the competition-they had already lost significant market share to competitors who had used this loophole to benefit students who were unhappy with their current lenders (most likely Sallie Mae or Citibank). Pressure was put on Rep. John Boehner, the head of the House Education Committee in 2005, and subsequently, the "super two-step" loop hole was closed. Sallie Mae Spokesperson, Tom Joyce, smugly predicted with the closing of the super two-step that smaller lenders would "think twice" about entering the student loan market.

There have been repeated attempts by smaller lenders to convince Congress to allow refinancing for student loans over the years, but all attempts have failed due primarily to the influence that Sallie Mae, Citibank, the Consumer Banker's Association, and others have enjoyed with key legislators on the Hill.

Statutes of Limitations

The 1998 amendments to the Higher Education Act also eliminated all statutes of limitations for the collection of student loan debt.

Exemption from the Fair Debt Collection Practices Act, Truth in Lending, and State Usury laws

State Guaranty Agencies are exempted from the Fair Debt Collection and Practices Act. For-profit student loan collection companies must adhere to this Act, but State Guaranty Agencies are exempt.

The 1998 Amendments to the Higher Education Act specifically exempts student loans from coverage under state usury Laws.

In addition, Student Loans are specifically exempted from coverage under Truth in Lending Laws.

More Congressional Giveaways at the Expense of the Student

In addition to the removal of standard consumer protections from borrowers of student loans, Congress passed legislation that made delinquent student loan debt highly lucrative through penalties, fees, and increased interest rates. In addition to massive penalties and fees, Congress afforded the industry draconian collection tools for the recovery of this increased debt. Most of these congressional "giveaways" to the industry were included in the 1998 amendments to the Higher Education Act, and were pushed fiercely by the student loan industry. Harvard Professor Elizabeth Warren told the Wall Street Journal that student loan companies "have powers that would make a mobster envious".

This legislation provided for a 25% increase to the balance of defaulted student loans to be attached to the debt immediately upon default by the guarantors of the loans. In addition, this legislation provided for annual "collection rates" to be attached to the debt. Borrowers who default on their loans are subject not only to a large increase in the debt upon default, but also face annual "collection rates" of often up to 25% of the balance of the loan. This has led to usurious situations that prompted a Senate investigation in 2007.

In order to collect on this debt, Congress provided the loan guarantors and collection companies with "powers that would make a mobster envious", according to Harvard Professor Elizabeth Warren. These powers include wage garnishment, tax seizure, social security garnishment, disability garnishment, suspension of state issued professional licenses, and even termination from public employment. Remember: harms caused by these collection tactics are over and above the harm caused to the borrower due to the negative marks on their credit records.

This legislation has proven to be extremely lucrative and profitable for Sallie Mae. In fact, in the 2003 Sallie Mae annual report, Albert Lord actually brags to shareholders that their record profits that year were attributable (in part) to fees and penalties collected on defaulted loans. Lords successor, Tim Fitzpatrick, has made similar claims in subsequent years in reports to shareholders.

Making defaulted student loans so expensive for the borrower, and also lucrative and easy-to-collect for the collection agent has given rise to collection companies such as Premiere Credit of North America, an Indianapolis, IN, collection company specializing in student loans. Premiere has done an amazing business in the past decade, and has even seen fit to install a 4000 gallon shark tank in the lobby of their corporate headquarters.

One common myth in America is that defaulted borrowers are robbing the taxpayers. In fact, it has been shown that not only do the guarantors and collection companies make a tremendous amount of profit from the collection of these loans, the federal government actually makes $1.20 for every dollar paid out in default claims.