Is it true that all good things come to those who wait?
For some struggling student-loan borrowers, that may finally be the case as some private student lenders recently announced plans to take more substantive measures to help.
The decision to modify a delinquent loan is a tough pill for lenders to swallow for a couple of reasons. Foremost is the concern that once the word gets out, less-troubled borrowers will claim distress or worse: Purposefully withhold their payments in order to score a better deal. The second has to do with lenders’ reluctance to come clean about the true nature of the loans they have on the books.
When full repayment at originally agreed-to rates and terms becomes uncertain, financial institutions will flag the loan so that they may more closely track remittances while looking for signs of deteriorating creditworthiness. But when the borrower is in or on the verge of default, the loan becomes nonperforming—probably the dirtiest word in a lender’s vocabulary.
To a lender, nonperforming loans are dead assets. That’s because going forward, every payment it receives for those loans must go toward reducing the outstanding principal, which means that no interest income may be recorded even if the borrower is able to pay all or part of the interest that’s due. Not only that, but the lender is also compelled to estimate the loan’s ultimate recoverability in the event of that default. It does so by subtracting from the principal balance its estimated value of the underlying collateral, if any. The difference is promptly written (charged) off.
By that accounting, nonperforming education loans—which are not collateralized—should be fully charged off, even though the debts are virtually impossible for the borrower to discharge in bankruptcy.
Consequently, private student lenders do all they can to avoid this from coming to pass, whether by agreeing to temporarily reduce or discontinue payments, or by actively managing a chronic delinquency so the contract doesn’t stray into nonperformance land.
The problem, however, is that these short-term tactics do little more than drop-kick the unsettled matter, frankly, at the expense of the borrower. Between late-payment fees and the compounding effect on all that deferred interest (known as negative amortization), the debt swells in value.
So when the lender decides it has no other option than to permanently modify the loan it wishes it hadn’t made in the first place, it can take any one or a combination of the following actions: lengthen the term, lower the interest rate and/or forgive a portion of the principal.
As you might expect, there is a pecking order for all this—one that favors lenders over borrowers.
Since nonperforming loans produce no income for the lender until the loan balance is repaid, it follows that the recovery of that principal is paramount. It also makes sense for the lender to collect at least some of the interest that it will be able to count as income once the loan is paid off. Therefore, a lender’s first offer will be to extend the loan’s duration.
Too bad the borrower ends up paying more in order to pay less.
You see, the longer a debt remains unpaid, the more interest it accrues. For example, a $30,000 private student loan that’s repaid over 10 years at 10% interest will cost $17,574 to finance over its life. But if the term were to be stretched to 15 years and the rate were to remain unchanged, even though the monthly payment will decline, that restructure will cost the borrower an additional $10,454—59% more for a total of $28,029 atop the originally borrowed $30,000.
So what’s a struggling education borrower to do when he’s already been granted the relief he needs for his government loans but his private lenders haven’t been as accommodating? Five things.
1. Make an Airtight Case for Relief
Be prepared to prove that you’ve tightened your budget to the point that you’re earning as much as you can and have eliminated all discretionary expenditures. The lender may ask for your bank and credit card statements for verification.
2. Don’t Settle for Temporary Measures if Your Problem Is Anything but Temporary
Lenders and their loan-servicing agents prefer bandages to surgery. If the financial distress you’re experiencing is permanent in nature (lower-paying job or disability, for instance), press for a solution that speaks to your reality. Escalate the matter to a supervisor or manager if you meet resistance.
3. Pay Attention to the Structure
Some lenders offer hybrid restructures, where interest rates are reduced for a few months or years. Sure, the payment will decline for a while and the interest you’ll pay overall will be less, but take care to determine whether you can live with the higher payments later on. If not, reject the offer.
4. Focus on the Fees
Whenever possible, lenders will seek to collect as much as they can in fees for arranging the relief you need. Not only are fees another form of interest in this context, they also represent the surrender of cash—a resource that’s already in critically short supply.
5. Prepare a Counteroffer
More than anything else, if financial institutions are after principal recovery, why not begin the negotiations by offering to do just that? Continuing with the previous example, if you can afford to make 10 years’ worth of payments at the 15-year rate (which calculates to $322.38 per month), and if $30,000 worth of debt divided by 120 months is $250 per month, why not begin the negotiations at that level and “settle” for $322.38? The lender will end up earning 5.28% on its loan instead of 10% and you’ll end up paying $8,686 in interest as opposed to $17,574—roughly half. (There are free online calculators to help you with the math.)
Certainly, that’s not a great outcome for the lender, but when an unsecured loan is headed into default, from the institution’s perspective, cutting a crummy deal today sure beats the time, expense and uncertainty of dragging the matter through the courts tomorrow.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.
More on Student Loans:
- How Student Loans Can Impact Your Credit
- Can You Get Your Student Loans Forgiven?
- Strategies for Paying Off Student Loan Debt