It could cost taxpayers $800 million to collect student debt from struggling borrowers

Two companies just won the opportunity to participate in the profitable business of collecting money from struggling student loan borrowers on behalf of the government.

The Department of Education disclosed Thursday evening that it selected Performant Financial Corporation and Windham Professionals Inc. to collect money from student loan borrowers who defaulted on their debt. The selection meets a court-ordered deadline to pick the debt collectors that would win the government business. It’s the latest development in years of litigation and protests over the lucrative award, which is likely only to continue as the losing bidders figure out how they will respond.

The selected companies could make $400 million

For the winners, receiving the contract is a big boost to their business. Performant’s PFMT, +19.07%   stock opened Friday more than 50% up from Thursday’s close. Michael Tarkan, a senior analyst at Compass Point Research and Trading, who follows the education industry, upgraded the company’s rating from buy to neutral on the news, noting that the contract could be worth up to $400 million for each company.

Persis Yu, the director of the Student Loan Borrower Assistance Project at the National Consumer Law Center, said she worries taxpayers aren’t getting the best value from the contract in its current form. A 2016 report from the Consumer Financial Protection Bureau found that in some cases, debt collectors earn nearly $40 for every dollar in cash they recover.

Advocates have raised similar concerns about companies hired by the Internal Revenue Service to collect back taxes. Those companies recovered $6.7 million in tax payments, but cost the government $20 million during fiscal year 2017, according to a report from the National Taxpayer Advocate, an independent organization within the IRS.

“It’s disappointing to see them move forward,” Persis Yu, the director of the Student Loan Borrower Assistance Project at the National Consumer Law Center, said of the Department of Education’s choice to hire firms under the current contract, “though not surprising.”

Concerns raised over the government’s two choices

Though the selection is great news for the companies picked, it presents concerns for borrowers, advocates say. For one, Secretary of Education Betsy DeVos had indirect financial ties to Performant, which raised concerns among some Democrats, The Washington Post reported last year. Ultimately DeVos divested from funds linked to the company after her confirmation.

But Yu said she has concerns beyond the firms selected to recieve the award. Yu, who has followed the Department of Education’s debt collection contracting process for years, said she’s troubled that the Department continues to award business to firms under the contract at all.

“That’s for me the big picture problem, this contract doesn’t work, this contract doesn’t benefit borrowers and I don’t think it benefits taxpayers either,” Yu said.

Borrowers can get nudged into unrealistic repayment plans

Borrowers are defined by the government as in default on their student loans if they haven’t made a payment in at least a year. Once a borrower defaults, the government has extraordinary powers to collect on the debt, including through garnishing wages, Social Security, and tax refunds. But there are ways for borrowers to get back on track.

Yu and other borrower advocates have complained that the government contract incentivizes debt collectors to only offer borrowers one way out of default, known as rehabilitation. That process requires borrowers to make nine on-time monthly payments over the course of 10 months.

Once borrowers finish making those payments, they transition to working with a student loan servicer, the companies that handle borrowers who haven’t defaulted on their debts. But as borrowers are handed off from one company to the next they sometimes miss opportunities to end up in the repayment plan that’s best for them — such as one of the government options to make loan payments that are tied to your income — putting them in danger of defaulting again.

The 2016 CFPB report found that more than 220,000 low-income borrowers who had defaulted on their debts would default again.

Borrowers have other choices besides rehabilitation for curing their default, but because the government pays debt collectors so much more when they complete a rehabilitation, the companies often nudge borrowers towards that choice, Yu said.

“In the experience of most of the clients that I’ve worked with, the collection agencies aren’t really doing an analysis to find out what’s best for borrowers,” Yu said. “There are a lot of options for borrowers and they need real counseling in order for them to get into the right program.”

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