How much does it really cost a student loan company to collect on a defaulted private student loan? That question is at the center of a class action lawsuit that a federal judge in California has allowed to proceed against Sallie Mae, the country’s largest private student loan provider.
The case was filed by four borrowers who have defaulted on private loans they took out from the student loan giant between 2002 and 2004 to attend Career Education Corporation’s California Culinary Academy in San Francisco. Before sending these borrowers’ loans to a collection agency, Sallie Mae added a collection fee of 25 percent to their loan balances in a process known as capitalization. As a result, the total amount each of the plaintiffs owed ballooned -- growing, in one case, from approximately $48,000 to $60,000 and, in another, from about $73,000 to $103,000.
While Sallie Mae’s actions in this case were not necessarily unusual, the lawsuit argues that the company violated the terms and conditions of the loans. At issue is the following clause that Sallie Mae includes in its private student loan promissory notes regarding potential collection charges:
“[Borrower] agree[s] to pay [holder] reasonable amounts permitted by law, including attorneys’ fees and court costs which [holder] incurs in enforcing the terms of this Note, if [borrower is] in default.” [Emphasis added]
The lawsuit contends that the 25 percent fee is "not reasonable" and has no relation to the true costs that Sallie Mae incurs when a borrower goes into default. Instead, the borrowers' lawyers argue that this is an arbitrary fee that is "designed to substantially exceed the collection costs actually incurred."
While “it would not be impracticable or extremely difficult to fix the actual costs of collection," the lawsuit says, Sallie Mae has not made “a good faith attempt” to do so. “The amount of the Collection penalties does not represent the result of a reasonable endeavor by Defendant to estimate a fair compensation for any loss that may be sustained."
Sallie Mae has responded to the lawsuit by trying to have it dismissed, arguing that the borrowers do not have "standing" to bring the case because they have not suffered any actual damages -- as three out of the four have not made any payments on their loans. But Judge Laurel Beeler of the U.S. District Court in Northern California rejected that argument, saying that the borrowers do not have to “show losses of money or property” to bring the suit. As long as the loan company has made “an attempt to collect the 25 percent collection fee,” the plaintiffs have suffered “a threatened injury (if not an actual one)," she stated.
Now that the case is moving forward, Sallie Mae officials will have to respond to the allegations -- and, in doing so, will presumably be forced to reveal how they came up with the 25 percent fee. Our guess is that they will justify their actions by noting that the U.S. Department of Education charges a similar penalty fee on defaulted federal student loans that it puts into collection.
For that reason, we believe that the Education Department should be asked the same questions that the lawsuit poses to Sallie Mae. Certainly, the government is well within its rights to have its collection costs covered when borrowers fail to fulfill their repayment obligations. But does the fee the Department charges reflect the actual costs it incurs, as this notice from the agency suggests? If the answer is "yes," then the Department should have to explain why its costs are so high and whether there's anything that could be done do to lower them. For example, would the agency's costs be lower if it stopped farming out this work to private debt collection companies (such as those owned by Sallie Mae) -- as consumer lawyer Deanne Loonin recommended on this blog a year ago?
Because after all, if the government and lenders like Sallie Mae want to get even the most financially distressed borrowers to repay their student loans, then the last thing they should do is send these borrowers into a debt spiral from which they cannot escape.
At Higher Ed Watch, we will continue to monitor this case closely. Stay tuned.