Student loan companies ‘abusing the bankruptcy system’ will face consequences: CFPB letter

Student loan companies will face consequences if they mislead borrowers and collect on private debt that has been discharged by a bankruptcy court, according to a letter sent by the country’s top consumer watchdog to Senator Dick Durbin (D-IL) that was obtained by Yahoo Finance.

“I am deeply concerned that borrowers are burdened by decades-old private student loan debt and potentially unlawful collection efforts,” Consumer Financial Protection Bureau (CFPB) Director Rohit Chopra stated in the March 8 letter. “I have directed CFPB staff to closely scrutinize these issues, including whether companies are making false representations.”

Senators led by Durbin and Sherrod Brown (D-OH) previously raised concerns to the CFPB over a report from the Student Borrower Protection Center (SPBC) that found student loan servicers misrepresented the possibility of discharging certain private student loans through bankruptcy proceedings.

FILE - In this May 8, 2019 file photo, then Federal Trade Commission commissioner Rohit Chopra testifies during a House Energy and Commerce subcommittee hearing on Capitol Hill in Washington.  Chopra, President Joe Biden’s nominee to run the federal consumer watchdog agency is likely to be face hostile questioning from Republican Senators on Tuesday, March 2, 2021,  but is likely to be confirmed with Democrats controlling a majority in the Senate.  (AP Photo/Susan Walsh)

Then-FTC commissioner Rohit Chopra testifies during a House Energy and Commerce subcommittee hearing on Capitol Hill in Washington on May 8, 2019. (AP Photo/Susan Walsh)

While “qualified loans,” those used to finance higher education at an institution that qualifies for federal student aid, require borrowers to prove an “undue hardship” to discharge the debt in bankruptcy, roughly $50 billion in debt held by 2.6 million borrowers is considered “unqualified” and therefore doesn’t have this requirement.

According to the SBPC, student loan servicers in some cases did not acknowledge discharge orders from bankruptcy proceedings and misled borrowers by telling them that their debt was not actually discharged.

“The practices described in the SBPC report raise concerns that these companies may not only be failing to comply with consumer protection laws but also abusing the bankruptcy system,” the letter from Chopra stated. “Lenders, servicers, and collectors of private student debt must honor the relief borrowers have obtained under the United States Bankruptcy Code and ensure their practices are in compliance with the Internal Revenue Code—or face consequences for their unlawful behavior.”

Student loan companies might ‘take the penalty’ and ‘keep doing it’

The CFPB’s letter is significant because it signals increased oversight of student loan servicers and a willingness to punish offenders.

Chopra, who formerly served as the CFPB’s first Student Loan Ombudsman, suggested that the CFPB is closely watching loan servicers to see if they are misleading borrowers by telling them that their private student loans are “never dischargeable” in bankruptcy. This comes after the agency had previously taken action against student loan servicers who had “falsely stated that borrowers who had completed bankruptcy could not discharge their loans.”

“This is very good news for debtors,” Matthew Bruckner, a bankruptcy professor at Howard University, told Yahoo Finance. “For servicers, it likely means that they’ll need to make further investments in correctly identifying collectible debts and properly training their staff and contractors. If CFPB actions force servicers to reform their collection practices or face lawsuits, debtors will benefit from the protections the bankruptcy code [is] intended to provide them.”

The CFPB’s letter suggested that the agency knew the problem existed and has always had the authority to act, Bruckner said, though the “agency is paying more attention to these issues than it may have been paying recently.”

At the same time, new enforcement actions by the CFPB may depend on whether lenders have recently changed their conduct, Bruckner added.

If lenders continue to mislead borrowers, it’s unclear if enforcement would effectively deter persistent bad behavior.

“I’m not always optimistic about agencies being able to step up and effectively regulate something because [penalties] can often be internalized as the cost of doing business,” Jason Iuliano, a bankruptcy expert and a professor at the University of Utah, told Yahoo Finance.

“If the sanction isn’t that great and that you’re collecting a ton of money” from discharged debt, he added, there is a possibility that these lenders “take the penalty” and “move on to keep doing it.”

Aarthi is a reporter for Yahoo Finance. She can be reached at [email protected]. Follow her on Twitter @aarthiswami.

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