For the last 10 months, it’s been one of the banking industry’s worst-kept secrets that Wells Fargo’s student loan servicing business was being investigated by federal regulators. Today, the Consumer Financial Protection Bureau confirmed these rumors and ordered Wells to pay more than $4 million in refunds and penalties over allegedly illegal loan servicing practices that increased costs and unfairly penalized certain borrowers.

The CFPB announced the action on Monday after identifying issues throughout Wells Fargo’s servicing process, including an alleged failure to provide important payment information to consumers, charging consumers illegal fees, and failing to update inaccurate credit report information.

According to the consent order [PDF] resolving the CFPB’s allegations, Wells Fargo’s Education Financial Services division — the second-largest private student loan issuer — failed to provide the level of student loan servicing that borrowers are entitled to under the law.

Specifically, the CFPB alleges that since Aug. 2012, thousands of student loan borrowers encountered problems with their loans or received misinformation about their payment options that may have resulted in financial harm, including excessive or unneeded late fees and incorrect credit reporting information.

Among the issues identified by the CFPB, Wells Fargo:

• Maximized costs and fees on some accounts: The way in which Wells Fargo processes payments led many accounts to incur additional late fees or penalties each month.

Specifically, if a borrower made a payment that was not enough to cover the total amount due for all loans in an account, the bank divided that payment across the loans in a way that maximized late fees rather than satisfying payments for some of the loans.

Additionally, the bank failed to adequately notified borrowers that it would allocate payments across multiple loans, and that consumers have the ability to provide instructions for how to allocate payments to the loans in their account.

As a result, the CFPB found that borrowers were not given the option to effectively manage their student loan accounts and minimize costs and fees.

• Misrepresented partial payment options: Wells Fargo’s billing statements incorrectly notified borrowers that paying less than the full amount due in a billing cycle would not satisfy any obligation on an account.

However, in reality, the CFPB found that for accounts with multiple loans, partial payments may satisfy at least one loan payment in an account, effectively eliminating one possible late fee. ‘

• Charged illegal late fees: The CFPB found that Wells Fargo often charged late fees on some accounts that weren’t actually late.

In some cases, the agency found that late fees were applied to accounts even though the borrower made a payment on the last day of their grace period. Additionally, some late fees were applied to accounts in which borrowers had chosen to make several partial payments throughout the month.

• Failed to update and correct inaccurate information reported to credit reporting companies: When Wells Fargo was made aware of the issues, it failed to update or corrected inaccurate, negative information reported to credit reporting agencies, the CFPB says, noting that errors could damage a consumer’s ability to access credit or make borrowing more expensive.

In order to resolve the loan servicing issues, the CFPB has ordered Wells Fargo to provide $410,000 in refunds to borrowers who were charged illegal late fees.

Refunds will be provided to borrowers who received late fees because of Well’s Fargo’s failure to disclose payment allocation process and failure to combine partial payments.

Additionally, the institution must pay a $3.6 million civil penalty to the CFPB’s Civil Penalty Fund, improve practices by allocating partial payments made by a borrower in a manner that satisfies the amount due for as many of the loans as possible, and provide explicit and truthful disclosures about payment allocations.

Consumer advocates applauded the CFPB’s action on Monday, while calling for industry-wide standards for all education loan servicers to ensure that everyone who carries debt after their education gets a fair shake while in repayment.

“We applaud the Bureau for using its supervision and enforcement authority to crack down on bad servicing practices like these,” Suzanne Martingale, staff attorney for our colleagues at Consumers Union, tells Consumerist. “Today’s announcement sends a strong message to the industry about what may constitute an unfair, deceptive or abusive practice related to student loan servicing.”

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