DEFAULT:

FFEL and Direct Loans: Failure to make required payment when due, if failure persists for 270 days: FFELP (20 U.S.C. § 1085(l); 34 C.F.R. § 682.200(b), and Direct: 34 C.F.R. § 685.102(b). Holder always accelerates the debt promptly after default.

Perkins: Failure to make a payment when due: Perkins: 34 C.F.R. § 674.2(b); school may later accelerate the debt.

CONSEQUENCES:

Credit bureau reporting and use of collection contractors: Holders of loans in all three loan programs must report the debt as delinquent or in default to national credit bureaus, and typically use collection agency contractors to perform collection activity after default.

Liability for collection costs: The HEA makes defaulters liable for “reasonable” collection costs. 20 U.S.C. § 1091a(b)(1). FFELP regulations direct each guarantor to compute “reasonable costs” using a “make-whole” method that computes the charge to each defaulter on the model of a guarantor-specific contingent fee. The charge to each defaulted FFELP debtor is assessed as a percentage of the loan balance, with that rate set to generate funds sufficient to reimburse the guarantor for the costs of collection efforts on its entire defaulted loan portfolio – not just on that individual loan. 34 C.F.R. § 682.410(b)(2). The regulations require the guarantor to offer the defaulter a brief initial opportunity, after the default claim is paid, within which the debtor can agree to repay voluntarily, without liability for costs. (34 C.F.R. § 682.410(b) (5)(ii).

Limits on Collection costs: The guarantor’s collection cost charge is capped at the amount Education would charge if Education rather than the guarantor held the loan – currently 25% of principal and interest. (Note that regulations mandate a lower cap – 18.5% - for payoffs by Consolidation, 34 C.F.R. § 682.401(b)(27) or rehabilitation transfers, 34 C.F.R. § 682.405(b)(1)(iv)).

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BANKRUPTCY

Bankruptcy – Who’s got the ball?
When a borrower files for relief in bankruptcy, how HEA loans are handled, and by whom they are handled, differs depending on the type of loan, the type of bankruptcy filing, who held the loan when the debtor filed, and whether the loan is already in default when the petition for relief is filed. In each case, follow the money and the identity of the holder will become apparent:

For FFELP loans:
Chapter 7 and 11: The lender (bank or secondary market) that holds a FFELP loan must file a proof of claim, but retains the loan through the bankruptcy unless and until the debtor files an adversary seeking a dischargeability determination under 11 U.S.C. § 523(a)(8). The holder then files a claim with the guarantor on the loan guaranty, and assigns both proof of claim and the loan to the guarantor. Education reimburses the guarantor for the full amount paid to the lender on the claim.

The FFELP rationale never imposes on lenders any obligation to litigate or deal with litigation of any kind.
Chapter 12 and 13: The lender must suspend collection efforts, file a proof of claim in the bankruptcy, and then promptly claim on the guaranty and assign both the loan, and the proof of claim filed on the loan, to the guarantor. The guarantor pays the lender on the claim. Education reimburses the guarantor for the full amount paid to the lender on the claim.

In all cases, after taking assignment, the guarantor is responsible for defending the debt against discharge. For State guarantors, this duty may be accomplished by raising sovereign immunity as a defense to adversary proceedings claiming undue hardship.
Non-defaulted FFELP loans held by guarantor: After the bankruptcy case is closed, either by dismissal or general discharge order, the guarantor must put any non-defaulted loans back to the claiming lender, or must sell the loan to another eligible lender, and must repay to Education any amount received from Education as Federal reimbursement for a claim on that loan.

The loan is treated as in forbearance during the stay period by the original lender (if that party holds the loan through the bankruptcy proceeding) or the purchasing lender. 34 C.F.R. § 682.402(f)(5)(ii). Interest accrues during this period and is capitalized unless paid as it accrues. 34 C.F.R. § 682.402(j)(2).

Defaulted FFELP loans held by guarantor: If a FFEL loan is already in default and held by the guarantor when the borrower files in bankruptcy, the guarantor must file a proof of claim that includes, in the amount in the proof of claim, a claim for collection costs, computed by the make-whole method described earlier. When the case is closed, the guarantor resumes collection activity on the loan.

Perkins Loans: The school similarly retains Perkins loans through the bankruptcy process, and like a FFELP guarantor, is responsible for defending the debt against discharge. For State postsecondary institutions, this duty may be accomplished by resisting undue hardship claims on sovereign immunity grounds. After the case is closed, either by dismissal or general discharge order, the school resumes collection action. The loan is treated as in forbearance during the stay period. Interest accrues during this period and is capitalized unless paid as it accrues.

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FORBEARANCE & DEFERMENT

Borrowers facing financial difficulty in meeting repayment obligations can switch to another repayment plan available for their kind of loan, or suspend or modify that repayment schedule by means of deferments or forbearances.

• Deferment is a suspension for specific causes of the obligation to repay; the borrower is entitled to a deferment upon demonstrating that qualifications are met.

• Forbearance is a temporary modification of an established repayment schedule either for inability to meet the existing repayment obligations or other specified grounds. Forbearances can suspend all
repayment, or can temporarily reduce the required installment amount. Generally, forbearances are within the discretion of the lender and are not a right of the borrower.

A. General comments on deferments and forbearances

• Deferments and forbearances are available prior to default and after rehabilitation, (which cures default – see below), but not while the loan is in default.

• Deferments: for those FFEL and Direct loans based on financial need, government will pay the interest accruing during deferments. Other FFEL and Direct, borrower is liable for accruing interest (can be paid as accrued or capitalized).

• Forbearances: debtor must pay the interest prior to end of forbearance or it is capitalized (added to principal balance)

• Whether particular type of deferment or forbearance is available depends upon many factors, including when the loan was taken out and if borrower had prior loans

• In general, borrower is limited to up to maximum of three years per type of deferment. Forbearances may be granted for up to one year at a time, but FFELP regulations do not limit the cumulative amount of forbearance periods.

Deferments:

Regulations:
Authority: FFELP - 34 C.F.R. § 682.210; Direct - 34 C.F.R. § 685.204; Perkins/NDSLP – 34 C.F.R. § 674.34 et seq. Each program has a variety of deferment grounds; several are focused on financial hardship, including unemployment deferment and economic hardship deferment.

1. Economic Hardship Deferment: available under all Title
IV Loan Programs; 34 C.F.R. § 682.210(s)(6) (FFEL); 34 C.F.R. §685.204(b)(3) (Direct); 34 C.F.R. § 674.34(e)(Perkins). Borrower must be --

a. receiving public assistance, or

b. working full-time (30 hrs/wk or more) with low income - at or below the HHS Poverty Guideline amount for family of two [for 2004, $1040.80 per month]1, or

c. working full-time, with high debt/income ration: (monthly income - student loan debt is less than $2289 (220% of amount in (b),

or

d. not working full-time, with low income [less than $2020 (2004)] and monthly income net of student loan payments lower than $1040.80 [amount in (b)].

[Note: (b), (c), and (d) formally require the qualifying income to be below the greater of the HHS Guideline amount or the minimum wage; the HHS Guideline amount now produces a larger amount than the minimum wage.]

2. Unemployment deferment available to borrower who is registered with unemployment agency if within 50-mile radius and has made at least 6 attempts during preceding 6 month period to secure full time work. 34 C.F.R. § 682.210(h)(FFEL); 34 C.F.R. §685.204(b)(2) (Direct); 34 C.F.R. § 674.34(d)(Perkins).

Forbearances:

FFELP 34 C.F.R. § 682.211; Direct Loan: 34 C.F.R. § 685.205; Perkins 34 C.F.R. § 674.33(d) --

a. Generally available where lender believes borrower intends to repay, but is unable to make scheduled payments because of poor health or other acceptable reasons.

b. Loan Debt Burden Forbearance Required where student loan debt burden equals at least 20% of monthly income; limited to total of 3 years. 34 C.F.R. §682.211(h)(2); 34 C.F.R. § 685.205(a)(6).

c. Military mobilization or national emergency: Required where Education Department determines that military mobilization or national emergency affects borrower.

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NON-JUDICIAL WAGE GARNISHMENT

When push comes to shove: Non-judicial wage garnishment: Repayment options & financial hardship objections to garnishment
Federal law now authorizes guarantors and the Department to collect defaulted loans they hold by non-judicial, “administrative” wage garnishment. Defaulters who do not come to repayment terms with the guarantor (for FFELP loans) or the Department (for any loan held by the Department) ultimately face enforcement by wage garnishment.

• Section 488A of the HEA, 20 U.S.C. § 1095a authorizes both guarantors and the Department to garnish up to 10 percent of the disposable pay of the debtor by an administrative order, without need for a judgment. Federal regulations require guarantors to use this tool, which is now the primary means of enforcing defaulted FFELP loans. 34 C.F.R. 682.410(b)(9). (Perkins schools do not have this authority.)

• The Debt Collection Improvement Act of 1996 enacted 31 U.S.C. § 3720D, a virtual clone of this HEA garnishment authority, which authorizes Federal agencies, such as Education, to garnish up to 15 percent of disposable pay. Education adopted regulations for this authority, 34 C. C.F.R. Part 34, 68 FR 8141 (2003), and has recently started relying on this new authority.

Both the HEA and DCIA require that the debtor be given notice of any proposed garnishment action, an opportunity to avoid garnishment by repaying voluntarily, and a hearing, on request, to dispute both the existence and amount of the debt, and whether withholding at the full rate authorized (10 percent under the HEA; 15 percent under the DCIA) would cause financial hardship. These rights are spelled out in the notices sent prior to garnishment.

Guarantors are free to use any method of evaluating hardship claims; some may use an ad hoc, financial statement-based approach; others, and the Department itself, use a method based on the standards adopted by the IRS for offers in compromise under IRC § 7122(c)(2). 2 The Department encourages, but does not require, guarantors to use this method.

Under this standards approach, a debtor who claims that garnishment at the full 10 or 15 percent rate of his or her disposable pay would cause financial hardship to him or her and his dependents must document the debtor’s household expenses and income. The garnishment order reaches only the debtor’s wages, but whether garnishment of the debtor’s wages will cause financial hardship to the debtor and his or her dependents requires consideration of both the household income as a whole, as well as the household expenses. The debtor’s expenses are then compared by the guarantor or Department with the amounts identified in the IRS standards as the average amounts spent for those same expenses by families of the same size and similar income as the debtor’s. Using data from census and other empiric sources, the standards determine average housing expenses on a county-by-county basis; transportation expenses, on a regional basis; and personal expenses, on a national basis. A debtor who claims to need to spend more for a particular kind of expense than the average amount spent by families in his or her cohort of the standards bears the burden of persuasion that the added amount is necessary.
The Department uses the standards method in garnishment proceedings both to determine the terms of voluntary repayment agreements and the amount to be withheld when agreement cannot be reached:

Repayment agreements:

• For those debtors who respond to a garnishment notice by seeking to repay voluntarily and do not claim hardship, the Department generally is willing to accept – without documentation of expenses - an installment payment arrangement under which the debtor agrees to repay in installment amounts equal to amount collectible at the full garnishment rate authorized (now, 15% of disposable pay). Current pay stubs are sufficient to establish the amount of disposable pay of the debtor. The repayment terms are subject to reevaluation periodically.

• For those debtors who respond to a garnishment notice by claiming hardship but indicate a willingness to repay voluntarily, the Department is willing to accept – upon documentation of income and expenses – an installment payment amount based on available income after necessary household expenses, measured against the standards, are met. If no amount appears available after expenses are met, the Department suspends attempts to garnish. Any repayment agreement or suspension of enforcement action is subject to reevaluation periodically, typically at six six-month intervals.

 2 Education and the guarantors that employ this method use it only to measure the reasonableness of expense claims, and not to determine the amount of debt that the individual will be required to repay to satisfy his or her obligation.

Amount to be withheld by garnishment order:

For those debtors who object to garnishment on hardship grounds but do not agree to repay voluntarily, the Department uses the standards in the hearing process to evaluate the hardship claim. Based on that evaluation, the hearing official may order withholding at less than the full amount authorized by statute, or may determine that withholding in any amount will cause hardship, and decide that no garnishment should occur. Again, a partial or complete hardship determination is subject to reevaluation periodically; if Education later determines that the financial circumstances no longer show that repayment would cause hardship, the Department will resume enforcement action, starting with a new notice of proposed garnishment, and an additional opportunity to object to that demand.

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