We all know Sallie Mae as the face of student loans. That is the entity you make the payments to, that is the entity you generally schedule in a Bankruptcy filing; but who is Sallie Mae?

News articles breaking over the weekend have added some light to that question. Sallie Mae is a publicly traded corporation that is about to be taken private for $25 Billion. Oh, and it is a corporation that has paid its CEO over $200 Million during a five-year period.

Some of the news articles have touched on how parts of the student loan industry work. According to CNN’s story Bonfire of the Universities 85% of Sallie Mae’s portfolio is Federally insured. That means that 15% is not. Something that I found very intersting is that in the event of default on a federally insured loan, the Government pays the lender between 96 and 98% of the total principal and interest owed.

So, why the emphasis on interest in that last sentence?

I am starting to see student loans that have been in default for a long time, because since 1997 virtually all student loans have been non-dischargeable; and since 2005 that is expanded to include completely private student loans — i.e., that other 15% of Sallie Mae’s portfolio. One thing that I am noticing on these loans is a ballooning of the account balance that just doesn’t seem right for loans at 8 or 9% interest. Then, I learned about interest capitalization.

I didn’t know until recently that in the event of default or at the conclusion of an approved forbearance period, a student loan lender may capitalize the accrued interest. That means add that interest into the principal balance so that interest accrues from that point forward on a much larger principal balance. This effectively makes a simple interest note a partially compound interest note — all of which is effectively non-dischargeable.

No sweat, thought right? After all, deferments followed by default should be pretty early in the note history, the two tend to go together so there is only one incident of capitalization; it shouldn’t make that much difference right?

Tell that to the client of mine who is now being told she owes $22,000 on a note that was written for less than $7,000. Oh, and even though she never made a payment after the deferment period (not uncomon, by the way); she has two capitalization events on her loan history — several years apart. Can anybody explain that to me?

So, why are we, the taxpayers, guaranteeing a return on investment and insuring investment losses for a corporation worth $25 Billion, that is paying out hundreds of millions in executive compensation and charging and capitalizing interest at 9%?

Elaine