A Bad Mix: Student Loans, Tax Debt, and Debt Collectors

The U.S. government long has used private agencies to collect defaulting student loans, and now tax debt is about to be added to the mix.

While recent college graduates are just beginning to learn important debt management skills, they sometimes are bombarded by the pressure of overbearing, inconsiderate, or potentially even unethical debt collectors. The Department of Education utilizes twelve major collection companies to target debtors of student loans. The success of the collectors in this arena subsequently has encouraged similarly aggressive tactics by the Internal Revenue Service.

In the meantime, student rates of default almost certainly will rise in the next five years. Default is preventable if borrowers are informed sufficiently, but, unfortunately, private collection efforts are gaining power and it is up to borrowers to educate themselves.

A major state study of student borrowers in Texas showed four interesting trends, each a warning sign of potential loan problems: (1) Inadequate counseling before the loans originated; (2) An inability to use college training for the intended career; (3) Lack of knowledge of repayment options; and (4) Combined life traumas. With the exception of uncontrollable life crises such as health problems, the first three issues can and should be addressed clearly.

It is never too soon to seek financial counseling and to have your questions answered. While counseling that is offered readily sometimes is insufficient, borrowers and parents should insist on face-to-face counseling sessions that will address adequately and fully all four of the above issues.

Private debt collectors now are being granted many of the same powers enjoyed by the government to collect debts on the government’s behalf. Federal debts like taxes and student loans can cause liens against federal income tax returns, federal benefits, or even savings accounts. Perhaps even more frightening is the ability of the government to garnish wages without a court hearing. I cannot be the only person concerned about private debt collectors inheriting such powers.

There also is a distinct chance that a single private collection agency may handle both tax debt and defaulted student loan. Loans actually are worth more if they are defaulted rather than just delinquent, and the reason is simple. In the case of a default, the government guarantees payment, so many lenders do not bother with trying to prevent it. A student’s slide in payments from late, to delinquent, to default is considered a “good” thing by many lenders. It is not a good thing for Congress, the loan programs, taxpayers and - of course - for student borrowers.

Unluckily still for borrowers, time is not on your side. Delinquency can drag on for nine months, usually after a grace period of six months, so there is an unfortunate lull between bankruptcy and default. This is like a ticking time bomb: Making a few, sporadic payments during this time without a plan actually can make the situation worse! Borrowers can become frustrated and lack resolution.

Voluntary agreements between educational agencies and the federal Department of Education are a great way to prevent default. Such agreements give great incentives for students and loan agencies to work together to prevent default, and do not reward default should it occur.

• Before you slide into default or even make a late payment, know what incentives your lender may offer you to make timely payments.
• If you are facing default, move quickly to adjust your income tax deductions to reduce any expected refund.
• Look into “ICR” or income contingent repayment plans almost immediately. Do not assume that you are locked into a rate; your situation is unique. As of 2006, however, only consolidated debt is eligible for ICR.
• Try to find out about potential cancellation of loan options. Schools that may close like cosmetology or acupuncture schools, for example, might grant you the right of canceling your loan.