Come January, dozens of private companies will bid to win lucrative government contracts to manage a chunk of the nation’s outstanding $1.3 trillion in federal student loan debt. At the forefront of that group will be Navient (NAVI), one of the four largest companies currently contracted by the government to service student loan debt for millions of borrowers. Navient, which already services more than $300 billion worth of student loan debt, was spun off from consumer banking giant Sallie Mae (SLM) a little over a year ago. It’s been plagued by legal troubles ever since, spurring consumer advocates and lawmakers to pressure the government to cancel the company’s contract. But so far the government hasn’t cut Navient. In fact, it renewed the company’s contract earlier this year. To understand why, Yahoo Finance took a deeper look inside the student loan servicing business.
In a white paper published in 2014, Roland Zullo, a research scientist at the University of Michigan, who has studied the use of private loan contractors in the federal student loan market, argued that the current performance review system used to award contracts to student loan companies doesn’t do enough to disincentivize bad behavior. The servicers’ performance is based on several factors, including customer satisfaction (weighted most heavily as 35% of their overall score), percentage of borrowers current on their payments, and the percentage of borrowers who have fallen behind on payments. The way the rating system works, however, servicers are guaranteed some loans no matter how high or low they score. A low score simply means you will get a smaller piece of the pie.
Servicers are somewhat penalized when borrowers fall behind on payments, but not enough to make it financially worth their while to spend time working with struggling borrowers, Zullo says. For example, the DOE pays loan servicers a certain amount of money each month for the accounts they manage. For the first 3 million accounts, the maximum monthly payout is $2.85 for each account that’s current. That rate drops to 45 cents for accounts 270 days past due, a loss of $2.45 per account per month.