Before a defaulted federal student loan is placed with a private collection agency, the Department of Education will notify the borrower and explain what can be done to avoid both the assignment to a private collection agency and the reporting of default status to the credit reporting agencies. If the borrower fails to enter into a repayment agreement, the loan will be accelerated (making the entire balance of the loan immediately due), and administration of the loan will be transferred from a loan servicer to a collection agency.
If the loan is placed with a collection agency, the borrower is responsible for collection costs up to 25%. Private collection agencies earn a commission for any payments made on loans. When the borrower makes a payment, the payment is first applied to the amount of the commission that the collection agency earned, the remainder of the payment will be applied to interest and principal on the loan significantly increasing the total cost of the loan.
In its collection efforts, the collection agency will first offer the borrower the option of entering into a voluntary repayment agreement. If the borrower does not agree, or if the borrower enters into a repayment agreement but fails to make payments, the collection agency will use administrative remedies including wage garnishment and treasury offset. If these efforts fail, the collection agency may recommend that a lawsuit be filed by the U.S. Department of Justice.