Every month, about 18,000 people reach an important milestone on the road to personal financial recovery. Having previously defaulted on their student loans -- because of lost jobs, chronically poor health or, yes, sometimes less sympathetic reasons -- they have gotten their acts together and consistently made on-time payments such that their loans are deemed ready for "rehabilitation."  Once a new lender buys such a borrower's loan, his or her credit record is wiped clean, as if the default never happened.
Here's the rub: The country's current economic mess has obliterated the market in which banks or other investors buy existing student loans, and while the U.S. Education and Treasury Departments have taken several steps to buttress that market, what they've done so far has not included rehabilitated loans. And as of Friday, Suntrust -- the lone lender that has been buying up nearly rehabilitated loans from the guarantee agencies (and the government) that hold them -- will no longer do so, which would leave borrowers who qualify for rehabilitation starting in December without a means of getting back into good graces.
Guarantee agencies believe the Education Department may have the authority to declare rehabilitated loans to be "new" loans that would qualify them for repurchase under one of the government's new efforts to prop up or rescue student loan funds, and argue that even if department officials decide that's not the case, that Congress should tweak the law to cover rehab loans. Officials at the Education Department say that its rules declare otherwise, but that they are aware of the issue and seeking potential solutions.
In the meantime, though, thousands of borrowers are likely to be hurt, loan industry officials say.
"These are a bunch of individuals who appear to have been forgotten in the programs that have been announced so far," said Tim Fitzgibbons, vice president for debt management services at the National Council of Higher Education Loan Programs, which represents guarantee agencies and other lending organizations. "And that's a shame, because there's an opportunity to invest in individuals who have turned their lives around, and done exactly what we want them to."
Although consumer protection and student advocacy groups have some qualms about how the rehabilitation program is operated -- focusing on whether too many borrowers are funneled into the repayment option when they might have better alternatives -- they generally agree that these borrowers deserve help to overcome this hurdle.
"People who, for whatever reason, had trouble repaying their loans, went into default, and then met all the requirements for rehabilitation deserve to have their loans rehabilitated," said Lauren Asher, associate director of the Institute for College Access and Success, which advocates on behalf of students on loan issues. "This procedural obstacle, which has nothing to do with the behavior of the borrower and is dependent on a random event in external markets, needs to be removed."
A Second Chance
Student borrowers in a position to have their loans rehabilitated have generally fallen far -- and climbed a long way back, too. They are among the significant minority of borrowers of federal student loans who are declared to have defaulted on their loans, a status that typically comes after they've been delinquent on their loans for nine months, usually after other efforts to help them (and forestall default) have failed.
At that point, the guarantee agency to which the original lender has turned over the loan has often alerted collection agencies, and it is at this point that the prospect of seeking rehabilitation, or repaying on terms that are meant to be reasonable and affordable for the borrower, becomes available.
(While Deanne Loonin, a lawyer for the National Consumer Law Center, supports the idea that borrowers on track to rehabilitating their loans deserve to have their loans recognized so they can get out from under their defaulted status, she is nonetheless concerned that the ranks of such borrowers have been inflated because guarantee agencies too often present rehabilitation as troubled borrowers' only option. Based on her clients' experiences, Loonin says, borrowers who are in default are often not told that they can consolidate their loans into the federal government's direct loan program, which would allow them to repay their loans using the government's income-contingent repayment program.
"The guarantors think rehabilitation is better for consumers, and sometimes it is," says Loonin. "But sometimes it isn't, and the key thing is that it's the consumer who should be making that choice, but he or she needs to be given all the options." Loonin also says that guarantors do not always peg the repayment terms of such loans at the "reasonable and affordable" level that federal law requires.)
Defaulted borrowers who decide to try to repay their loans become eligible once again to receive federal financial aid once they have made six consecutive payments, under Education Department rules, and a borrower who makes 9 out of 10 on-time payments qualifies to have his or her loan -- once an investor buys it -- deemed "rehabilitated."
In normal times, guarantee agencies have sold bunches of such loans to banks or other investors that see them as a worthy asset, and "under normal market conditions, these loans were actively sought out," because the borrowers have shown their willingness and ability to overcome the odds and pay them off, says Fitzgibbons of the council of loan programs. (The Education Department, to which guarantee agencies turn over some of the defaulted loans that they have given up on collecting, uses much the same process to rehabilitate an additional number of federally guaranteed loans.)
But as the credit markets have seized up in recent months, making it much more difficult -- and in some cases impossible -- for lenders to find investors willing to buy many types of student loans, the federal government has taken a series of steps to make the loans more attractive to potential investors. To date, though, the various programs -- most of which were enabled through a new law called the Ensuring Continued Access to Student Loans Act  -- have applied only to newly issued loans, and at this point, at least, the U.S. Education Department appears to be interpreting the law in a way that excludes rehab loans, says Brett E. Lief, NCHELP's president.
Lief's organization and guarantee agencies acknowledge that the federal efforts so far to buttress the student loan industry have focused, appropriately, on the biggest fish -- the millions of students who take out federal loans each year -- and that the tens of thousands of holders of rehabilitated loans may seem like a distant second priority.
But they are hoping that the government sees fit to take one of several possible steps -- declaring the loans eligible for the "lender of last resort" program, for instance -- that would make rehabilitated loans attractive enough to investors to allow them to be sold. If the department does not believe it has the authority to make rehabbed loans eligible for funds through student loan law on its own, Lief says, guarantors are hopeful that Congress will consider tweaking the law to make it so.
Education Department officials have taken the position that rehab loans cannot be declared to be "new" because they remain the same loans throughout the process. The department continues to discuss ideas with loan industry officials, including the prospect that a lender could purchase some of these loans and include them in "conduits" that would issue "asset-backed commercial paper" to attract money from private investors. This was one of the new ideas that the department unveiled earlier this month  to buttress the federal student loan system.
With Suntrust's agreement to purchase rehab loans expiring Friday, and no solution in place, it seems unlikely that any remedy will be available in time to help borrowers who will be eligible to have their loans rehabbed next month.
"Without some action," says Fitzgibbon, "we'll be saying to borrowers, 'Sorry, we know you've worked hard to pay off your loans, but you have to stay in default because we can't find a buyer for your loans.' "