If you default on a student loan, the creditor—often the Department of Education if you have a federal student loan—may send your account to a collection agency. If this happens, the debt collector can charge collection fees in addition to the amount that you already owe. When it comes to private student loan, your student loan contract or state law usually sets the collection fees.
When the Department of Education sends your federal student loan to a collection agency, the agency keeps a portion of what you pay without sending it to the Department. When you make a payment, the payment first gets applied to the amount of the commission that the private collection agency charges, and the rest of the payment goes toward paying off the interest and principal on your loan.
A percentage of every payment that you make on your student loan goes towards the collection fees. For example, if a collection agency charges 25%, and you pay $1, only $.75 will be applied to your loan balance. The rest ($.25) will go towards the collection fees.
So, if you default on your federal student loans, the balance can significantly increase.
There is no law capping what debt collectors can charge for collection fees on federal student loans. However, collection fees must be “reasonable.” Collection agencies usually set fees as a percentage of the total principal and interest that you owe on your student loan or as a portion of your payments.
Collection fees are limited in a few situations.
For most federal student loans, collectors generally must limit their fees to 25% of the loan balance (principal and interest). For Perkins loans, though, the fees can be up to 40%, depending on the situation. Sometimes, however, collectors charge a fee that's a percentage (say 20%) of the payment.
The collection agency must apply this percentage to your principal and interest only, not to any collection fees which it has already charged to you and added to your balance.
Collection agencies can charge collection fees if you rehabilitate or consolidate your student loan.
Rehabilitation. If you enter into a rehabilitation agreement, the fees generally depend on the type of loan you have. For Department-held loans, the fee is usually 20% of each payment. For other loans, fees vary.
Consolidation. The collection agency may charge fees as much as 18.5% if you consolidate. The fee will be added to your new loan balance, and considered to be additional principal.
The amount of collection fees that debt collectors can charge to collect private student loans is set by your promissory note, which is the contract you signed when you got your student loan. Whatever collection percentage is in your promissory note is the maximum that the debt collector can charge, unless your state law sets a lower limit.
Because the promissory note sets the collection fee percentage, if the collection agency sues you on defaulted private student loans, the court might not allow it to get a judgment for collection fees if the collector can't provide the court with a copy of your promissory note.
If you can pay off the entirety of your interest and principal, some collection agencies for private lenders will waive the collection costs.