With or without student loan relief, we must reform the default system

Whatever the outcome of the legal challenge to President Joe Biden’s student loan forgiveness plan — which was recently argued before the Supreme Court — millions of borrowers will still owe billions of dollars. That makes this the best time to fix long-standing problems that have undermined the ability of many borrowers to repay loans that were suspended because of the COVID-19 pandemic but are slated to resume later this year.

Student loan default — defined as nonpayment after 270 days — is far more common than many imagine: A recent survey fielded for The Pew Charitable Trusts found that 35 percent of federal undergraduate borrowers who entered repayment across two decades had a defaulted loan, and 66 percent of those who defaulted experienced a default multiple times. 

And some current economic trends raise concerns about how borrowers will fare once payments resume. For example, rising consumer debt delinquencies among student loan borrowers since early 2021 indicate that a significant number of these borrowers are struggling to manage financial obligations even before student loan payments are reintroduced, which could put many at risk of default.

The Department of Education recently made or proposed a host of policy changes to address the needs of struggling borrowers, including the Fresh Start initiative, which gives borrowers an opportunity to get their loans out of default. The department also recently proposed revisions to income-driven repayment that will make monthly payments more affordable for many borrowers once implemented.

These are important steps in the right direction. And there are signs that policymakers are considering major changes to the way in which loan defaults are handled. In fact, the Department of Education has signaled that it’s pursuing a rulemaking designed to address student loan debt collection practices.

Nevertheless, the underlying default system currently remains unchanged, as do the associated consequences. Default penalties can include negative marks on a credit report, collection fees, wage garnishments and ineligibility for more federal financial aid; tax refunds and Social Security payments can also be confiscated.

A recent brief from Pew that we coauthored using survey data helps illustrate how the consequences imposed on borrowers with defaulted loans can undermine their repayment success. The survey asked borrowers who have experienced a default to describe the penalties they faced, the financial impact of those consequences and whether they were aware of the potential consequences before seeing their loan default.

Among survey respondents, 84 percent of borrowers who experienced default reported facing serious consequences, with most experiencing two or more. Many borrowers said that the penalties they faced had major financial impacts, and they mentioned sadness, anger and hopelessness (among other reactions) when describing the emotional toll of those penalties. And although borrowers were generally aware, before experiencing default, that default could carry consequences, they were often unaware of the specific effects they might face.

And the consequences of default often fall hardest on borrowers who are already financially insecure. For example, past research suggests that borrowers who experience default tend to have lower incomes and greater financial needs as students. Black and Hispanic borrowers and women disproportionately experience default, highlighting the role that housing and labor market discrimination, among other systemic factors, have played in creating disparate outcomes.

This practice of imposing significant consequences on a group of borrowers who are often financially vulnerable raises serious questions about the extent to which these penalties actually help borrowers get back on track with repayment or, instead, send them into a cycle of redefault.

The Supreme Court will rule sometime this year on President Biden’s plan to forgive some student loan debt. But no matter what the court decides, many borrowers will likely be susceptible to student loan challenges in the future. It’s critical that policymakers capitalize on this opportunity to reshape how the student loan default and collections system operates by advancing reforms to student loan default policies, and that they do so in a way that guides struggling borrowers onto a successful repayment track.

Ilan Levine is an associate, Phillip Oliff is a project director and Ama Takyi-Laryea is a manager with The Pew Charitable Trusts’ student loan research project.