Higher education negotiators and the Department of Education wrapped up the second round of negotiated rulemaking on student loan issues this week. Officials from the Department provided draft proposed regulatory language for sixteen separate loan issues - including two particularly incendiary topics, preferred lender lists and prohibited inducements - for consideration by negotiators. The Department's draft language was for consideration only and provoked several animated discussions through the three day negotiations. This article summarizes the discussions and implications of those draft proposed regulations.

Some Issues Left Off

Officials from the Department did not provide draft proposed regulatory language for six of the issues that were discussed in the first round of negotiations. Although they remained on the agenda and open for discussion, they were in effect "dead issues" since the absence of any draft regulatory language prohibited further discussion. Those six issues included:

• Reasonable and affordable Title IV loan rehabilitation payments
• Additional disclosures to borrowers in repayment
• Aligning repayment start dates for Stafford and Grad/PLUS Loans
• Standardizing hardship appeal policies and practices for administrative wage garnishment and other Federal offset programs
• Economic hardship deferments and income contingent repayment plans
• The cessation of collection activity during loan rehabilitation

No new language was drafted for these issues for a variety of reasons including excessive cost and because officials at the Department felt they had no statutory authority to provide any.

Draft regulatory language for identity theft was also not provided, although the Department hopes to be able to provide language for that issue prior to the next and final round of negotiations.

Entrance Counseling for Graduate and Professional PLUS Borrowers

The Higher Education Reconciliation Act (HERA) made graduate and professional students eligible for PLUS Loans under the same terms and conditions as parent PLUS borrowers.

In the first round of negotiations in December 2006, concerns had been raised about the lack of mandatory entrance counseling for a Grad PLUS Loan. Negotiators representing schools voiced concern about lenders that "push" borrowers into Grad PLUS without mentioning Stafford Loans. Dear Colleague Letter FP-06-05 requires schools to offer students Stafford Loans prior to the Grad PLUS. Students are currently under no obligation to take those Stafford Loan funds prior to accepting the Grad PLUS, and students who only accepted Grad PLUS Loans miss entrance counseling offered to students taking out Stafford Loans.

The Department provided draft regulatory language that would mandate that prior to certifying a PLUS Loan application for a student borrower, a determination of eligibility for a Stafford Loan would need to be made and the borrower would have to be made aware of the availability and terms of the Stafford Loan. Additionally, the draft regulations would mandate that all student PLUS Loan borrowers receive entrance counseling, in the exact manner that Stafford Loan borrowers receive counseling.

While some discussion about implementation ensued, most negotiators felt it was in a student borrower's best interest to receive entrance counseling.

Maximum Length of a Loan Period

A request was made during the first round of negotiations to eliminate the maximum 12-month loan period for annual loan limits currently stipulated in the loan programs. In response, during the second round the Department provided draft regulatory language that would allow institutions to certify a single loan for students in non-term or nonstandard term programs. Schools would still use the definition of an academic year as defined in 34 CFR 668.3, but would no longer need to worry about exceeding a 12-month period. Negotiators had few comments on the proposed regulatory language, signaling their general agreement as to its implementation.

Frequency of Capitalization

During the first round of negotiations, Jennifer Pae, from the U.S. Students Association, proposed that capitalization on consolidation loans for students with an in-school deferment should occur at the same rate as Stafford and PLUS Loans. Current Stafford and PLUS Loans capitalize interest when a student experiences a status change (i.e., withdraws, graduates, drops below half-time). Current regulations for consolidation loans state that capitalization must occur "no less often than quarterly."

Given the high number of borrowers who consolidated their loans while in school in the last few years, such a regulation would protect them from excessive interest charges, according to Pae. This would also assist borrowers with consolidation loans that return to school after periods of hiatus. Most negotiators supported the proposal; Department representatives had said they would consider it.

In response, the Department's draft regulations would stipulate that capitalization on consolidation loans during any period of deferment or forbearance can occur only when the borrower changes status at the end of those authorized deferment or forbearance periods. Few comments were given by negotiators.

Simplification of the Deferment Granting Process

Under current regulations, borrowers seeking a deferment (other than an in-school deferment) must contact each one of their loan holders and supply each with justifiable deferment documentation. The Department's draft of regulatory language would allow FFEL lenders to grant graduate fellowship, rehabilitation training program, unemployment, economic hardship, and military service deferments based on information from another FFEL loan holder or from the Department of Education. In the case of Direct Loans, the Department would also be able to grant deferments based on information from a FFEL lender.

If the regulation is adopted as drafted, borrowers would only need to apply for a deferment with one lender or servicer. This would assist borrowers with multiple lenders, who sometimes forget that obtaining a deferment with one lender does not mean that their loans with other lenders will automatically go into deferment.

Eligible Lender Trustees

The most recent HEA Extension Act eliminated the ability of a FFEL lender to enter into an eligible lender trustee (ELT) relationship with a school or "school-affiliated organization." Previous negotiated rulemaking conversation revolved around the regulatory definition of a "school-affiliated organization."

At that time, some negotiators noted that some organizations are amorphous, claiming to be school-affiliated when it serves their purpose and not affiliated when it doesn't serve their purpose. For example, alumni associations sometimes claim to be school-affiliated and at other times claim complete independence from the institution.

Negotiators questioned if a lender could use an organization like an alumni association to setup an ELT. Others cited athletic associations and boosters as another possible candidate for future ELTs. Most thought it would be good to better define parameters to comply with the intent of the law, but many questioned how regulation could be drafted to effectively address the issue.

In the second round of negotiations, the Department provided draft regulatory language that would add to the definition of a "school-affiliated organization." As drafted, the definition would state: "a school-affiliated organization is any organization that is directly or indirectly related to a school and includes, but is not limited to alumni organizations, athletic organizations, and social, academic, and professional organizations."

Drafted regulatory language also reaffirmed the elimination of any provisions that allowed eligible trustee relationships, unless an agreement was in place prior to September 30, 2006.

Institutional Preferred Lenders

Negotiators spent a substantial amount of time in the previous round of negotiated rulemaking discussing preferred lender lists. The second round was no different. The Department drafted proposed regulatory language to provide limits and conditions on how an institution develops and uses a preferred lender list. The draft regulatory language states that schools may provide a list of available lenders only if it:

• Does not impede a borrower's ability to choose any lender
• Contains at least three lenders
• Does not contain any lender that has offered - or that has been solicited to offer by a school - any financial or other benefits to be a part of the preferred lender list

Additionally, schools using preferred lender lists would need to provide disclosures to prospective borrowers outlining the school's methodologies in compiling their preferred lender list, comparative information about interest rates and borrower benefits between lenders, and a statement that informs the borrower that they are not required to use any of their preferred lenders.

Schools would also be prohibited from assigning a lender to a borrower during the packaging or awarding process and would not be permitted to delay any loan processing based on the borrower's choice of lender. Many of the non-federal negotiators suggested the ED draft language was overly-burdensome. Others suggested the regulation went too far making all schools comply with intrusive regulations that are unnecessary given that problems have been few and isolated. Everyone agreed that a borrower's choice of lenders is sacrosanct and should be protected with the provision of better counseling and more prominent written notices. Some of the non-federal negotiators defended the draft regulations as necessary to prevent abuse of preferred lender lists by schools and lenders.

Prohibited Inducements

Officials at the Department have drafted regulatory language beyond what is provided in CFR 435 (d)(5) and 428 (b)(3) of the HEA. As drafted, the regulations would provide what the Department deems an exhaustive list of both allowable and prohibited activities that lenders may provide to students, schools, or other lenders. Prohibited activities would include the following:

• Payments or offerings of any kind - including prizes to a prospective borrower in exchange for a loan application
• Payments or offerings of any kind to the school or any organization directly or indirectly affiliated with a school in exchange for loan volume
• Payments to any student acting as a lender's representative at a school
• Payment of referral or processing fees to another lender that exceeds "reasonable compensation for the handling and marketing of loan availability" based on loans made on behalf of a lender
• Payment of entertainment expenses for employees at a school or any organization that is directly or indirectly affiliated with a school - including "private hospitality suites, tickets to shows or sporting events, meals, alcoholic beverages, and any lodging, rental, transportation, and other gratuities related to lender-sponsored social activities"
• Below-market terms of financing or below-market rates for loan origination and servicing to a participating FFEL school lender

The draft regulations would specify that lenders may provide:

• Assistance to schools comparable to assistance provided by the Department to schools in the Direct program.
• Temporary, emergency, staffing services to a school
• Support of a guaranty agency's college access and student outreach activities
• The cost of support for meals, refreshments, and receptions that are scheduled in conjunction with open meetings or conferences
• Toll-free telephone numbers for use by schools
• Borrower benefits such as reduced origination fees and interest rates
• Payment of the default fee by guarantors on behalf of students - as long as it is provided in a non-discriminatory manner (this is in regards to race, sex, ethnicity, etc.)
• Items of nominal value that are given as tokens of good will

Negotiators expressed concern that the Department viewed these lists as exhaustive in nature, stating that their hope was that the Department would offer guidelines as opposed to a list of do's and don'ts. Lender negotiators stressed the importance of a quid pro quo philosophy, stating that a direct linkage needed to be made between lender activities in exchange for increased loan volume.

Many felt that despite the Department's efforts to offer a list of allowable and prohibited activities, the draft language was both vague and overreaching. If accepted as currently written, the draft regulations could have serious consequences because they seem to reach into areas outside of Title IV.

The lenders underscored the complexity of their business by giving examples of how different areas of a lender's organization may be involved with an institution. For example, many fear that the new regulations would prohibit lenders from investing in school's sports arenas, providing philanthropic funds to school endowments, and a myriad of other activities that lenders provide to schools completely outside of Title IV.

One negotiator expressed concern about borrower benefits that seem to be offered to students only at particular schools, questioning the motives of lenders that selectively give borrower benefits to students at professional and graduate schools while leaving students at community college and trade schools behind. According to the negotiator, students at community colleges and trade schools are subsidizing the borrower benefits of graduate and professional students.

Lenders argued that fiscal restraints prohibit them from offering borrower benefits to borrowers at all schools and that their own research into the needs of students has shown that some students are in greater need of benefits up front (e.g., paid origination fees) while other borrowers are in need of borrower benefits during repayment (reduced interest rates). Lenders also pointed out that an examination of cohort default rates shows that it is the professional and graduate students that are subsidizing the loan program for students at community colleges and trade schools.

Some negotiators also expressed concern over the provision that allows lenders to provide temporary staff to an institution in times of emergency. These negotiators felt that it would be unethical to have lenders be in a situation where they are working directly with borrowers - under the appearance of being a member of a school's financial aid office staff - or processing loan applications and/or completing need analysis.

Negotiators also felt that when lenders provide temporary staff to schools, it hinders fair competition.

"When a school becomes dependent or reliant on a particular guarantor or lender, it creates a ‘marriage;' so while there is no explicit quid pro quo, that is what it becomes and it puts other lenders at an enormous disadvantage when competing for that loan volume," said one negotiator.

Lenders countered that they offer those services to all schools, regardless of whether or not the lender is on the school's preferred lender list. One lender negotiator from a nonprofit state agency explained that at times they provide temporary staff to assist with many state financial aid issues, not just lender issues and that these staff members are generally provided to smaller schools with only one or two persons on the financial aid staff.

Overall, negotiators agreed that the regulatory language should be simple and seek to accomplish two goals:

1. The prohibition of any quid pro quo exchanges between lenders and schools
2. That borrowers are not coerced into using one lender over another

True and Exact Copy of Death Certificates

Current regulations require parents who borrowed on behalf of a deceased dependent to produce an original or certified exact copy of a death certificate before processing a Death Discharge. Officials from the Department have drafted new regulatory language that would allow for a "true and exact" copy of the death certificate to be used in a death discharge. A simple photocopy would meet the requirement as "true and exact." Negotiators agreed that this new provision would ease the burden on families, who may already feel burdened by the death of a loved one.

Lender negotiators once again asked the Department to consider alternate documents, such as certified notification from a funeral director or documents from the Social Security Administration, to satisfy the necessary requirements. Lenders also asked the Department to consider the determination by one lender or guarantor, and as shown on NSLDS, as enough proof to discharge all loans held by other lenders and guarantors.

Retroactive Total and Permanent Disability

Current regulation stipulates that borrowers who seek loan discharge through total and permanent disability (TPD) must go through a three-year conditional period wherein they are not allowed to take out another loan or receive annual income earnings that exceed 100 percent of the poverty line for a family of two from the date the borrower became totally and permanently disabled as certified by a physician.

In the previous negotiated rulemaking session, the Department expressed concern that current regulations stipulate that the three-year conditional period begins on the date of physician's certification. This results in an occasional situation where students have already completed their three-year conditional period by the time the Department receives the discharge request.

The draft language would provide for a prospective conditional discharge period, stipulating that the three-year conditional period would begin on the date that the Secretary makes the determination that the borrower is eligible for TPD. Borrowers would not be able to use additional Title IV loans from the date of the physician's certification for TPD.

Negotiators questioned whether consolidation loans would be considered "new loans" under this statute. During a conditional discharge period, some students may consolidate their loans to ensure a low interest rate in case the Secretary rescinds the discharge at the end of the three-year conditional period. The Department would need to consider whether a consolidation loan would be considered a "new" loan.

NSLDS Reporting Time Frames

Regulations require schools and guarantors to specify their reporting requirements to the National Student Loan Data System (NSLDS), but there is no such requirement for lenders. The Department drafted regulatory language that would require schools, guaranty agencies, and lenders to report enrollment, loan status information, and all other required data to the NSLDS by the deadline date established by the Secretary. Additionally, the draft regulations would require guarantors to begin reporting to NSLDS within 30 days of a borrower or loan status change, as opposed to the 60 day requirement currently required.

Retention of MPNs

Master Promissory Notes (MPNs) are used in all Title IV loan programs. Because MPNs can be used for a 10-year period, no loan amount or loan period is recorded on the face of the note. When the Department seeks payment through legal action on a defaulted account (including accounts subrogated to the Department by guarantors which are unable to collect), it must be able to provide evidence to the court that the student benefited from the proceeds of the loan.

The Department contends that the yearly reconciliation process takes care of this issue on Direct Loans but no such mechanism is in place for FFEL Program loans. Schools hold this information, but they currently do not have to retain it beyond three years.

Under the draft version of the regulations, a lender and guarantor would be required to maintain a record of the institution's delivery of each loan disbursement to a borrower and to ensure that a record of the lender's authentication and signature process is submitted to and by the guaranty agency.

This provoked a lively discussion between the Department and negotiators, who were largely against any provisions that would require schools to deliver records back to the lender showing the institution's delivery of loan funds. Many felt that it would be overly burdensome for schools to report back to the lenders to confirm delivery of funds for each disbursement.

Lenders asked if schools could simply provide that information to the Department on an "as-needed" basis. Schools responded that they could provide that information to the Department, but would not want any regulations that would require schools to retain records beyond the three years currently required by regulation.

Schools also questioned whether the cost of implementing such a system outweighs the need by the Department to litigate effectively.

"Why provide it all when you might only need [it for the] 5 percent of all borrowers that go into litigation," asked one negotiator from an institution. "Either way, schools will have access to the student's account, which is better than a date in a data field held by the lender."

Lenders went on to contend that they were confident that records currently held by lenders, guarantors, and schools would be sufficient for any potential litigation in the future.

The lenders concluded that if the officials from the Department intend on keeping the draft regulations, that they consider having this information collected on NSLDS as opposed to being held by the lenders.

Perkins: Child or Family Service Cancellation

The Department provided draft regulatory language to specify that for in order to qualify for a child or family service Perkins Loan cancellation, a borrower must be a full-time, non-supervisory employee of a child or family service agency providing services "directly and exclusively" to high-risk children from low-income communities.

While no real issues were identified, the Department feels that the additional wording in the draft regulations clarifies the existing regulations.

Perkins: Reasonable Collection Costs

The Department raised concerns in the first round of negotiated rulemaking about the high collection costs assessed on defaulted Perkins Loans, which can sometimes be as high as 30 or 40 percent. Program regulations stipulate "reasonable" collection costs are applicable to defaulted Perkins Loans, but the term "reasonable" is not defined in regulation. The Department drafted a regulatory change that would cap collection costs for Perkins Loans at 24 percent of the unpaid principal and accrued interest of the loan.

According to the Department, collection costs for the Perkins Loan program should be comparable to the collection costs of the Direct Loan program, which is somewhere around 16 percent. Lender negotiators were quick to point out that the Department was giving a blended rate that may not really reflect the true collection costs of many Direct Loans.

One negotiator also pointed out that it is the Department that requires that schools use a collection agency to collect on defaulted Perkins Loans. She stated that it would be difficult for schools to comply with that regulation under a capped collection cost model.

Collection costs are the same whether it is a small balance or large balance, the negotiator explained, so the collection cost percentage rises on loans with smaller amounts. She stated that because 67 percent of Perkins loans in collections are under $2,000 (compared to around $10,000 in the FFEL program) collection costs make up a higher percentage of the loan than in other programs.

A percentage cap on the collection costs would make the Perkins Loan Program an unsustainable program, according to the negotiator. Another negotiator stated that collection costs are generally accounted for in the interest rate, but given that no additional funds are being made for the Perkins Loan program, it appears to be an unsustainable program.

The Department asked if negotiators felt that a percentage cap would ever be a viable option, and if so, what such a cap might be. Negotiators responded that since the industry average seemed to be around 28 percent, the number had to at least start there. One negotiator proposed a sliding scale that would allow a dollar amount cap on smaller loan amounts and a percentage cap on larger loans amounts. The Department concluded that it would review the regulatory language prior to the next round of rulemaking sessions to be held in March.

Mandatory Assignment of Defaulted Perkins Loans

Mandatory assignment to the Department of a defaulted Perkins Loan is required by HEA only if the school holding the loan has knowingly failed to maintain an acceptable collection record with respect to the loan. In the previous rulemaking session the Department claimed that this regulation prevents them from stepping in and reclaiming loans where they feel they could do a better job of collections. The Department stated that Perkins Loans that have been outstanding without payment for more than five years shows a failure of due diligence and that mandatory assignment of those loans should be required.

The draft regulations would require mandatory assignment "at the Secretary of Education's discretion" of any defaulted Perkins loans to the Department if:

• The amount of the loan is $50 or more
• The loan has been in default for more than five years
• No payment has been received on the loan within the previous year

The Department contended that since the late 1990s, schools have not done a good job of collecting on those defaulted Perkins Loans and that those funds should be returned to the Department.

One negotiator opposed the draft language, stating that it would not be in a school's best interest to return any loans to the Department since any funds collected would be turned over to the U.S. Treasury and not back to the school - in effect depleting the Perkins Loan program even further.

"I think the Department is on pretty shaky statutory authority to force assignment," the negotiator said.

"The Department responded that the school's program participation agreement gives the Department authority to take any action to ensure the United State Government against any substantial financial risk and that the Department looks at these defaulted, uncollected loans as substantial financial risk.

Negotiators asked if it would be more appropriate for the Department to enforce mandatory assignment only on schools with high cohort default rates.

The Department stated that it would consider all suggestions prior to the next and final round of rulemaking in March, 2007.

By Justin Draeger
NASFAA Assistant Director for Communications

Posted 02/13/07 to www.NASFAA.org. Redistribution to non-NASFAA institutions is prohibited. Please submit Web Site questions or comments to Web@NASFAA.org.