Monday, May 04, 2009

The Student Loan Scam

In the last month, I have been introduced to an issue which I think I should call to the attention of anyone who reads this blog: the Student Loan Scam. I have spent the last several weeks reading online message boards and chatrooms with people suffering through various stages of this scam. This is probably one of the greatest frauds perpetrated in American history by a special interest group against American, and I would strongly urge anyone who is considering taking out a private student loan to think long and hard about the ramifications.

Back when I entered college in 1996, I used federal Direct Loans as a way of bridging the gap between how much college cost and how much my "wealthy" parents would be expected to contribute to my education. Of course, there were some who declared bankruptcy to avoid paying back their loans, so in 1997 congress and the Clinton administration made student loans non-dischargeable in bankruptcy and retroactively eliminated the statute of limitations. While my own payments were rather high, the federal government, with its main motive being to get its money back to loan to the next student, was willing to work with me to refinance at a lower rate and help me find a payment plan I could afford. After five years of hard work in America, I was out of debt and could continue with my life.

But as college costs have continued to rise at double the rate of inflation, a new type of loan, the federally-backed private loan, became more popular as the Direct Loans were no longer able to cover the costs of tuition. In this loan scheme, private lenders, such as Sallie Mae, are encouraged to extend credit to student borrowers by a guarantee that, should the borrower default, the federal government would reimburse the lender for the loss. It seemed like a reasonable system, except for one critical flaw: the lender now no longer had any profit incentive to keep loans out of default since they would get their money back either from the student or the federal government.

But that was only the beginning. Over the past decade, Sallie Mae, Citibank, and other private lenders have begun taking over all aspects of the student loan business, from kickbacks to universities, to lubricating Congress and the Bush administration into passing the Bankruptcy Reform Act of 2005 removing all consumer protections from student lending, to purchasing all the debt collection companies tasked with pursuing delinquent student loans.

The business model of Sallie Mae and other private lenders now works as follows:

1. A prospective college student speaks with a financial aid officer who directs them to accept a loan from Sallie Mae. The then 18 year old student is told that payments on the loan will be $350 per year when he or she graduates from college. Unbeknownst to the student, the financial aid officer and the university receive kickbacks from Sallie Mae for each loan issued, and thus often steer students away from loans which would have a lower interest rate or longer term. This also benefits the university in that the availability of easy credit drives up the price of tuition, much as happened in the housing market.

2. The student graduates from college and is shocked to receive his or her first bill, not for $350 but for $800. The student aid officials and loan officers are not accountable because the bankruptcy reform act of 2005 exempts them from all honesty in lending laws.

3. The student goes into forebearance until he or she can find a job which will pay for this loan. At this stage, sometimes Sallie Mae pretends not to have received the students' paperwork and throws the loan immediately into default. Sometimes the student pays for a while until Sallie Mae can tack on enough "late fees" and interest to finally make the total bill unpayable. Sallie Mae does not offer flexible repayment plans like the federal government, since their profit motive is to push the lender into default. The 2005 Bankrupcy Reform Act makes refinancing or consolidating private student loans impossible. Either way, many students end up in default and Sallie Mae is reimbursed for the entire value of the loan by the federal government.

4. A credit collection agency purchases the delinquent debt back from the federal government for pennies on the dollar. After a few calls or letters, often to previous addresses from which the credit agency knows the lender has moved, a $20,000 legal fee is slapped onto the total amount. This is permitted by the Bankruptcy Reform act of 2005.

5. The credit collection agency sells the debt to another credit collection agency which slaps another $20,000 onto the debt. This process continues several times, until the total amount on a $40,000 loan can reach $200,000 or $300,000, or any number which is clearly beyond the student's ability to pay. Astronomical interest rates apply. Of course, all of these collection agencies are wholly owned subsidiaries of the Sallie Mae Corporation.

6. The credit agencies then sue the defaulted borrower. The borrower is of course unable to pay, or pay for a legal defense, due to the shortage of money that caused the default in the first place. The court passes judgment and the credit agencies garnish 25% of the student's salary and intercept all tax returns. The garnishment often results in the new employee being fired. The 2005 Bankrutpcy Reform Act also allows the collection agency to sue and revoke any professional licenses (medical, legal, engineering etc). Because there is no longer a statute of limitations on the debt, and the amount is far beyond the borrower's ability to repay, and this continues for the borrower's entire working career. When the borrower retires, Social Security is also garnished.

7. For borrowers who are sick or disabled, the debts can also not be discharged because the standards for disabled discharge of debts were set so high in the 2005 Bankruptcy Reform Act as to be impossible. Disability payments are also garnished.

Garnishment is actually a worst case scenario. Usually debt collection agencies will accept a payment plan from the student. The payment plan continues over five or six years, when suddenly the credit agency goes out of business and the debt is resold to another credit agency and the lawsuit-garnishment-settlement process begins again. The new credit agency often claims none of the debt has been paid, and the borrower will have a very hard time getting payment reports from a shady credit agency which has gone out of business.

So who benefits from this, besides, of course, Sallie Mae investors who's stock increased 1600% in a decade, Sallie Mae Executives, and the financial accounts of politicians who sign onto legislation like the Bankruptcy Reform Act?


In all the message boards I've read through, the only people who have successfully broken out of "Student Loan Hell," as they call it, are those who have left the country. While I have seen a few posts calling people who pay back their loans "suckers," most of the defaulted borrowers are burdened with an enormous sense of guilt and fear. It's only after having suffered through broken marriages, lost jobs, and having usually paid back several times the original loan value, before they give up and decide to pack their bags and escape the dominion of Sallie Mae. As one message puts it:

Posted By Jennifer Peoria, IL: October 25, 2008 2:04 pm

I work in a small, Canadian technical recruiting agency in their immigration profile division. Almost every applicant we get now is from the US and all running from student loan debacles. We gladly here them and assist in immigration if they meet the qualifications which include high skill sets, particularly in software development and engineering. It is definitely a brain drain towards Canada. When they do arrive they love our health care and social services and our retention rate is over 90% measured for a 5 year span. As Canada has a lower birth rate than the US, our program will double in the next year due to the overwhelming number of applicants. Furthermore, the cost of pursuing a student debtor here would cost about $40k CAN. It's simply not worth the return as a Canadian court would be far more lenient, blaming the lender as much for the predicament. Since a Canadian Social insurance Number will allow a new credit profile, many of our applicants are able to start over up North. We have terrific feedback from our clients, the companies that do the hiring and pay us for recruiting.

So America's northern neighbor inherits a generation of highly-trained professionals at no cost to itself whatsoever. You have to wonder what future a country has when its predatory lending laws drive a significant percentage of its best and brightest into exile.

Addendum: If you have been caught up in this scam, there is a political action committee, Student Loan Justice, which is dedicated to taking action on this issue. Of course, since this system was set up with government collusion, there is as of yet no legal escape from Sallie Mae (at least as long as you are alive.) But you can at least meet others in a similar situation and learn from their experiences how


NormanF said...

An American higher education today is astronomically expensive and of little real benefit.

Thanks to the cost and debt ratio to value, more young people are skipping college. And student loan terms such as you have outlined are making this all the more attractive.

What if they held classes and no one came to attend them?

Evan said...

In my experience, most people actually DON'T show up to a lot of classes :) At least when I went.

What people fail to understand is that you don't have to pay $40,000 per year to take classes on literature and art history. And most of the people paying $40,000 aren't as interested in the subject matter as they will be in the piece of paper they are awarded at the end.

The next few years will experience a reappraisal of the true value of overinflated products. Houses are now being reappraised downward, and soon the cost of diplomas in fields which do not produce enough income to cover the loans will be as well.

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eng 301a said...

I'm glad someone isn't afraid to call these scam artist out.

My husband and I recently had to file bankruptcy due to issues unrelated to the student loan we cosigned for my daughter.

A quick lesson on reading the contract. Apparently if any party files bankruptcy the loan goes into default reguardless of the payments being made or, in our case, the student still being in school..
The collection agency is demanding the college student get a 40 hr a week job to start payments now and drop out of school!

Evan said...


Thanks for the link.

eng 301a,

I'm so sorry you got caught up in this scam. I'm hoping these companies can be put out of business as soon as possible. There's only so much blood these crooks can squeeze from the middle class before there is a reaction.

Zapporah said...

Please answer me this... I just graduated college and I am moving to Israel in just a few months. Can I escape these high loan amounts in Israel? What will happen to my credit rating in Israel? Is it the same as in Canada with the new social number? What will the repercussions be for me in Israel?

Thank you so much for this article.

Evan said...

HI Zapporah,

There is no such thing as a credit history in Israel. At this time, lenders do not persue delinquent debtors outside of the United States. Also, there is no debtors' prison or anything like that, so you can fly back and visit as desired. Please note, however, that as of the writing of this comment, there is still no bankruptcy or statute of limitations on student loans. Therefore, if you default, and then you return to the U.S. after 20 years, your debt collectors will be waiting for you. Also, over the next 20 years, there could be a change in finance laws which makes it easier to persue debtors abroad. Nobody really knows which direction this will go. But for now, you will be safe from the loan collectors.

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Michael said...

If you lived in Canada you can get one of the best student loans ever - a Canada student loan. The taxes are high in Canada but it's used for the right reasons - health care and education. More countries should follow their lead but not the greedy USA.

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