Why student loan debt collections could be more painful than anticipated

The clock started ticking on a financial time bomb this week for student loan borrowers — those in default will now be referred to debt collections.Why it matters: Because of the messy state of the student loan world, the economic fallout could be far more widespread than anticipated, hitting some who typically would be able to pay back loans. It also comes amid recession fears, worries over higher inflation, and a slowdown in hiring.By the numbers: The 5.3 million who already are in default could see the federal government garnish their wages, Social Security benefits or tax refunds.Many more are in limbo. Some 20% of borrowers are in delinquency, but not yet at the default line — more than 270 days past due — according to a report earlier this week from credit agency TransUnion.That's up from 11.5% in February 2020, when the federal government stopped asking people to pay on their loans. Between the lines: Before 2020, typical defaulters, and those most at risk for default, were more likely to be older, low-income, people of color, those who attended for-profit schools or had dropped out of school. Now because of policy chaos, more at-risk borrowers are outside those confines, says Constantine Yannelis, a financial economics professor at the University of Cambridge, who's been studying student loans for more than a decade."I'm most worried about young people who are just going to be tremendously confused by the student loan system," he says, especially "given the complete disarray that we're seeing in public institutions these these days."Zoom out: Many of these people would normally be able to avoid default, and work out a payment plan. But the mechanisms meant to help them navigate the process are in shambles.The White House gutted the Department of Education, which manages student loans. It is trying to do the same to the Consumer Financial Protection Bureau, which helps folks navigate the financial system."This feels very much like it needs to be an all hands on deck effort, but they have dramatically cut the number of hands they have available," says Sarah Sattelmeyer, project director in the Higher Education initiative at New America.For example: Earlier this year, Eva Steege, an 83-year-old pastor in hospice care, joined a lawsuit against the Trump administration over its CFPB policy. The agency had been helping get her loan forgiven, a process interrupted by the administration's changes.Steege died March 15. Her "fear of leaving her surviving family members saddled with her student loan debt came to pass," federal judge Amy Berman Jackson wrote soon afterwards, in a ruling on the case.Yes, but: This isn't a mess the current White House started.The roots of the problem started in 2020, when the government told borrowers they no longer had to make payments. The Biden administration extended that grace period for three years.Plus: The program was poorly implemented and overly generous from the start, says Tomasz Piskorski, a finance professor at Columbia Business School, who wrote a major study on debt forbearance in COVID, published by Brookings.It was different from other kinds of pandemic debt relief programs, like for mortgage holders, who had to apply (and few did). For student loan borrowers, everyone got a pass. That's created a bigger problem. The bottom line: Getting out of this situation is going to be ugly for a lot of people at a not-great time for the economy — or higher education.Says Piskorski: "This is kind of the worst time to ask people to pay back debt."

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