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The Myth of Record Low Default Rates

Published:  July 22, 2010

Until fairly recently, policymakers and college leaders were pretty well convinced that they had eradicated the default rate problems that had once plagued the federal student loan program. After all, year after year, the U. S. Department of Education would announce, with great fanfare, that the official rate at which borrowers were defaulting on their student loans had reached a new record low (see here, here, and here).

Federal officials all the way up to the President would use this occasion to boast of their great skill in managing the federal student aid programs. At the same time, for-profit colleges, which experienced the most dramatic reductions in their rates, would present the results as evidence that they had overcome the problems of the past and were indeed faithful stewards of taxpayer dollars.

But as The Chronicle of Higher Education so ably documented in a set of articles this month, much of this progress has been illusory. The articles, written by my former colleagues Kelly Field and Goldie Blumenstyk, show "that the government's official 'cohort default rate,' which measures the percentage of borrowers who default in the first two years of repayment and is used to penalize colleges with high rates, downplays the long-term costs and defaults, capturing only a sliver of the loans that eventually lapse." Examining unpublished Education Department data, the Chronicle found that "one in every five government loans that entered repayment in 1995 has gone into default," and that the rate reached 40 percent for borrowers who had attended proprietary schools.

Meanwhile, the Chronicle's reporting also clearly shows that changes Congress made in 2008 to help the government more accurately measure the student loan default rate did not go far enough.

Undermining an Accountability Tool

Congress put the two-year cohort default rate in place in 1992 as part of a broader effort to crack down on fly-by-night trade schools that were set up solely to reap profits from the federal student aid programs and didn’t provide the meaningful training students needed to get jobs and pay off their debt. Each year, the Education Department calculates default rates for all of the colleges that participate in the federal student aid programs. Colleges with rates of more than 40 percent in one year or at least 25 percent for three consecutive years can be dropped from the programs.

For a while, the cohort default rate served as an effective tool for weeding out problem institutions. In fact, throughout the 1990s, the Education Department barred more than 1,000 schools from continuing to participate in the federal aid programs because of their high rates.

But over time, for-profit colleges became more and more adept at skirting the rules, and their friends on Capitol Hill made it easier for them to do so.

In 1998, Congress extended by three months -- to 270 days from 180 days -- the length of time before the government declares a delinquent borrower to be in default. That extension significantly delayed the moment at which the government must take responsibility for a bad loan and reimburse the bank that made the loan. Here's how our former colleague Ben Miller described the delay in a Higher Ed Watch post back in 2008:

Once [a borrower reachers the 270 day mark] it takes an additional 90 days for the government to pay the insurance claim. This means that it takes roughly 360 days, basically a full year, for an unpaid loan to officially be counted as going into default. These 360 days do not, however, include the 60 day grace period most borrowers have to make their first payment. In other words, a borrower who decides to never pay back a single penny of student loan will not be considered in default until roughly 420 days after their first payment was due.

As Miller wrote more recently on Education Sector's The Quick and the Ed blog, "The amount of time it takes to default is so long that pretty much the only people caught in a cohort default rate were those who never even made a payment on their loan."

Meanwhile, for-profit colleges quickly learned that they could manipulate a flaw in the law to avoid the sanctions.

As long as borrowers are in deferment or forbearance, they are not required to make payments on their loans and are not in danger of defaulting. But the Higher Education Act requires the Education Department to include such borrowers among those who are successfully repaying their loans in the default rate calculation. In other words, to determine default rates, the Department must divide the number of borrowers who default in a given two-year period by the total number of borrowers who are making payments on their loans during that time. As the Department's Inspector General explained in a report in 2003, by including borrowers in deferment and forbearance in the amount of those who are in repayment, the Department artificially reduces the overall default rate and that of individual colleges. In addition, if these borrowers eventually default, they are never counted.

Proprietary schools have seized the opportunity to drive down their rates by hiring companies to aggressively push high-risk students to get forbearances and deferments on their loans. Their sole purpose has been to prevent these students from going into default during the two-year window when defaults are counted against the school by the Education Department. Ironically, the schools' intervention has left some of these borrowers worse off. While obtaining forbearance allows borrowers to stop making payments temporarily, interest continues to accrue on the loans, ballooning the size of the overall debt load.

According to The Chronicle, the percentage of borrowers in deferment or forbearance more than doubled between fiscal years 1996 and 2007, from 10 percent  to 22 percent.

Trying to Make Things Right

When it reauthorized the Higher Education Act in 2008, Congress took an important first step in helping the government more accurately measure the rate at which borrowers default on their loans.

Starting next year, the Education Department will officially include in the official cohort default rate all borrowers who fail make payments on their loans within three years of college, rather than two. The Department will begin holding colleges accountable for the three year rates in 2014. At that time, a default rate of 30 percent for three consecutive years will result in a school losing access to federal student aid funds.

This improvement will effectively remedy the problems caused by the 1998 change. Unfortunately, the legislation did not do anything to address the underlying issue of who is or is not counted in the cohort default rate. This failure means that proprietary schools will continue to be able to disguise how their students are doing repaying their loans (by pushing them to take advantage of deferments and forbearances, as well as the relatively new Income-Based Repayment (IBR) program). As Blumenstyk's article shows, some of these institutions are already going "full bore" to insure that the new-and-improved three-year rate is as deceptive as ever.

We will explore this topic further soon. Stay tuned.

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