Government

In 11th-Hour Move, Education Dept. Spares the Rod on Loan Defaults

September 24, 2014

On the eve of the much-anticipated release of its annual roundup of student-loan default rates, the Education Department has announced that it will spare some colleges whose high rates would have cost them their ability to award federal student aid.

In a notice published quietly on Tuesday, the department told colleges it had "adjusted" the rates of institutions that fell short of the strict new standard that took full effect this year, excluding some defaulters from the colleges' totals.

Colleges, many of which depend on student aid for their survival, welcomed the news. College leaders have argued that recent growth in the share of borrowers defaulting on their federal student loans is due in large part to factors the institutions can’t control—a weak economy, for one, and inadequate loan servicing, for another.

But student and consumer advocates accused the department of letting underperforming colleges off the hook and of undermining lawmakers’ efforts to hold those institutions accountable. They questioned the department’s decision to offer relief to colleges, but not to the borrowers whose loans are in default.

As many as two to three dozen colleges had been at risk of losing their eligibility under the stricter standard, which holds colleges responsible for defaults that occur over three years, rather than two. The department did not say how many institutions would remain eligible as a result of its adjustments, though the secretary of education, Arne Duncan, told a gathering of leaders of historically black colleges and universities on Tuesday that none of their institutions would be penalized.

In a speech at the department's National HBCU Week Conference, Mr. Duncan credited the "tremendous effort we made together" with defusing the threat to colleges.

"The hard work of lowering default rates remains, and some institutions remain troublingly close to the line," he said. "But we will continue to work with you to address this critical issue with urgency."

If HBCU leaders knew the announcement was coming, community colleges were pleasantly surprised. Those institutions, which have seen their default rates rise from 13 percent to 21 percent over the past six years, had been anticipating this week’s default-rate release with anxiety and dread.

What About Borrowers?

Congress raised the default-rate standard five years ago, in part to make it harder for colleges to manipulate their rates. Before, some colleges would routinely use deferments and forbearances to push defaults beyond the government's two-year measurement window.

Under the new standard, penalties kick in when a college’s cohort default rate—the share of students who default on their loans in a given period—exceeds 30 percent for three years in a row or 40 percent in a single year.

With the shift to a three-year standard looming, colleges have been scrambling to bring down their default rates. A growing number have turned to third-party vendors for default-management and financial-literacy services.

But default rates have continued their steady climb. Last year the percentage of borrowers who defaulted within two years of entering repayment reached 10 percent—the highest rate in nearly two decades—while the percentage defaulting within three years reached almost 15 percent.

While the struggling economy explains some of the increase, colleges also blame legislative changes that have resulted in some borrowers’ having loans assigned to more than one servicer. They say borrowers with "split servicing" are more likely to default on their debt than are borrowers with a single point of contact.

"A 50-percent jump in rates is not explained by the recession alone," said David S. Baime, senior vice president for government relations and research at the American Association of Community Colleges. "It did have to do with the servicing environment."

In the Tuesday announcement, the department acknowledged the difficulties that split servicing had caused some borrowers, without providing evidence that such borrowers default at higher rates.

To account for such borrowers, the department removed from its calculations those who had defaulted on a loan but who had one or more loans in repayment, deferment, or forbearance for at least 60 consecutive days, explained Jeff Baker, policy director for the Office of Federal Student Aid.

"In some cases, these adjustments resulted in an institution not being subject to a potential loss of eligibility," he wrote. Then, almost as an afterthought, he noted that "the borrower’s defaulted loan remains in its current status."

Consumer advocates say that’s not fair. "If schools are not going to be held responsible for defaults presumed to be caused by split servicing, borrowers shouldn’t be either," said Debbie Cochrane, research director at the Institute for College Access and Success.

In a written statement, the top Democrat on the House education committee also raised concerns about the department's reprieve.

"Any changes in the student-loan system that reduce transparency and consistency may compromise our ability to hold poor-performing colleges accountable," said Rep. George Miller, of California.