Student Debt-Relief Services Come Under Scrutiny

State and federal authorities are raising concerns over companies that promise to help student-loan borrowers ease their financial burden but charge hefty fees for what regulators allege are unnecessary services.

Illinois Attorney General Lisa Madigan said she plans on Monday to file civil lawsuits against two firms—First American Tax Defense LLC and Broadsword Student Advantage LLC—that she alleges charge upfront fees to enroll borrowers in programs they could sign up for themselves at no cost.

Representatives for First American and Broadsword couldn't be reached for comment.

The U.S. Consumer Financial Protection Bureau in March began supervising nonbank student-loan servicers, which collect payments and handle other back-office functions. The agency previously has raised concerns about the potential pitfalls of debt-relief services targeting student-loan borrowers.

The moves show that regulators and prosecutors are increasing their focus on the $1.2 trillion student-loan market as debt increases and more borrowers struggle to keep up with their payments.

"These operators charge a very hefty upfront fee," Ms. Madigan said. "All they're doing is signing people up for free government programs."

Some services make false promises, charging fees that can surpass $1,000 for programs that consumers are able to apply for at no cost on their own, Ms. Madigan said.

New York's top financial regulator earlier this year subpoenaed 13 debt-relief firms targeting student-loan borrowers over similar concerns. A spokesman for the New York Department of Financial Services said its investigation is ongoing.

The services mirror pitches made to struggling homeowners after the mortgage meltdown to ease their financial burden.

"Some of these troubling reports from borrowers remind us of some of the worst practices in the wake of the meltdown of the mortgage market," said Rohit Chopra, the student-loan ombudsman for the CFPB.

Data from the U.S. Department of Education show that 10% of borrowers who began paying back their federal student loans between October 2010 and September 2011 had defaulted by Sept. 30, 2012. The percentage has increased for six consecutive years, according to the data.

The National Consumer Law Center, an advocacy group, said in a report last year that some student-debt-relief firms charged up to $1,600 in upfront fees and ongoing monthly fees of as much as $50.

A spokeswoman for the U.S. Department of Education said the agency offers students options to consolidate federal student loans for free, and the Obama administration has expanded income-based repayment options while reaching out to "struggling borrowers to make them aware of the flexible options available to repay their debt."

The spokeswoman didn't comment on third-party debt-relief services.

Debt-relief services in and of themselves aren't illegal. Federal and state rules govern when such firms can charge borrowers fees. Under an Illinois state statute that took effect in 2010, debt-relief firms aren't allowed to charge fees to customers until they obtain an agreement with a borrower's creditor to reduce the consumer's debt, and a payment must be made to the creditor under the agreement.