New Measure of Student-Loan Defaults Could Threaten Hundreds of Colleges

December 14, 2009

More than 220 colleges have long-term student loan default rates so high that they would lose all federal student financial assistance under the terms of a new law that eventually will measure those rates over a three-year time scale, according to new Education Department figures.

That's more than six times the number exceeding the current limit, in which the department considers defaults over a two-year period and makes colleges ineligible for federal aid—a source of money that is critical to the survival of most institutions—if too many of their past students fail to pay back their loans on time.

The change from a two-year to a three-year measure doesn't take full effect until 2014. The Education Department calculated compliance rates under the three-year period and publicly released the numbers on Monday as a way of helping institutions prepare. (The figures are available from the department's data center; click on "Trial Three-Year Cohort Default Rates.")

Student-loan defaults are more common at for-profit colleges and other institutions that serve lower-income populations, and the move toward a stiffer default-rate measure has left many of those institutions warning of a growing harm to the students most in need.

"The only thing that explains default rate is the socioeconomic background" of the student, said Harris N. Miller, president of the Career College Association, which represents for-profit institutions. "By using that as the metric of quality, you will always be discriminating against low-income students."

An Education Department official disagreed, saying that nearly two decades of experience has shown that using loan-default rates as an institutional eligibility measure doesn't deprive poor students of college but merely spares them from attending bad colleges.

The default-rate requirement culled out hundreds of colleges a year when it first took effect in the early 1990s, said Daniel T. Madzelan, acting assistant secretary for postsecondary education, yet college enrollment nationwide is now at record levels. "Students evidently found alternatives," Mr. Madzelan said.

One of Several Measures

College students nationwide now collect about $24-billion a year in Pell Grants, the main federal support for low-income students, and borrow about $84-billion a year in government-subsidized loans. Such federally backed money can make up as much as 90 percent of the revenue at many colleges.

The rate at which a college's former students default on their federally subsidized loans—generally meaning they haven't made payments on the loans for more than 270 days—is one of several measures the federal government uses to help ensure taxpayer-supported student aid is being spent for legitimate educational purposes.

It's the students, rather than the taxpayers, however, who ultimately benefit from lower default rates, Mr. Madzelan said. That's because student loans generally cannot be dismissed even in bankruptcy, meaning the federal government eventually makes more money from students who default on their loans than it loses, he said.

Most students are required to begin paying back federally subsidized loans six months after they graduate or otherwise leave school. A college can lose eligibility for both grants and loans if its default rate exceeds 40 percent among its former students in the first year after they're due to begin repayment. Colleges also can lose eligibility if the rate of borrowers defaulting within two years of their scheduled start of repayment is 25 percent or greater for three consecutive years.

A new law, the Higher Education Opportunity Act (HR 4137), approved last year by Congress, will change that last measure, effective in 2012, to begin counting borrowers who default within three years of their scheduled repayment. Using that three-year window, colleges would be ineligible if their borrower default rate is 30 percent or greater for three consecutive years.

Among more than 5,000 colleges with students receiving federal financial assistance in the 2007 fiscal year, only 36 institutions with at least 30 students in repayment had default rates of 25 percent or greater on the two-year measure, according to the new Education Department data. But 221 colleges had default rates of 30 percent or greater on the three-year measure, the data showed.

No college with the minimum number of borrowers exceeded the 25-percent level for three consecutive years using the two-year measure, said Benjamin Miller, a policy analyst with Education Sector, an independent think tank. As many as 40 colleges, however, may have exceeded the 30-percent level for three years using the three-year measure, Mr. Miller said.

Nationwide, the average rate of default on a federally subsidized student loan was 6.7 percent in 2007, the Education Department announced in September. The new data being released on Monday, however, shows the average default rate for fiscal 2007, when calculated on the three-year measure, was 11.8 percent, Mr. Miller said.

Congress adopted the three-year window after some lawmakers argued that many institutions and their partner lenders, whose eligibility for the federal program is also tied to default rates, were avoiding declaring a borrower in default until just after the two-year measuring period had passed.

Counseling Tied to Mandate

Colleges don't necessarily deny the tactic. Some of them, along with partner banks that provide federally subsidized student loans, might now respond to the new law by simply extending their efforts to delay defaults by one additional year.

The ATI Career Training Center, which prepares workers in fields that include health care, personal fitness, automotive repair, and welding, saw the student-loan default rate at its 1,355-student Dallas location rise from 27 percent under the two-year measure to nearly 50 percent under the three-year window, according to the Education Department data.

Arthur E. Benjamin, chief executive of the for-profit institution, said that jump largely reflects the fact that the center in Dallas stopped providing its former students with loan-counseling assistance after the two-year period.

"As a result," Mr. Benjamin said, "the three-year rate released is not reflective of what the rate would be had the institution continued to provide counseling and assistance to its students for the full three-year period." In the future, he said, ATI will extend that counseling by another year and thereby "substantially" reduce its default rate for the new three-year measuring period.

Still, it's not a fair gauge, said Mr. Benjamin, who serves on the Board of Directors of the Career College Association. Congress should at least consider local economic conditions when basing education policy on default rates, he said. The government otherwise might "depress a region's potential for future economic development," he said.

Central State University, a public four-year institution in southwestern Ohio, has similar concerns. Central State, with about 2,000 students, saw its default rate grow from 22 percent under the two-year measure to 33 percent under the three-year window, according to the Education Department data.

The university has many graduates, including grade-school teachers, whose jobs simply don't pay enough to cover the cost of attending college, said Phyllis Jeffers-Coly, dean of enrollment services. Sanctioning universities based on default rates, she said, is "not dealing with the fundamental question of, How are we going to make college affordable?"

Obama's Graduation Goal

That problem should be especially evident to President Obama, said Harris Miller of the Career College Association, given the administration's stated goal of having the world's highest proportion of college graduates by 2020. The government does need to guard against putting those students in substandard colleges, he said, but it could do that by developing better systems for measuring student success and job placement. The default rate, he said, is a less direct and less accurate measure.

The government does use other methods to deter substandard institutions, including regular reviews by accreditors of curricula and facilities. And the fact that only a handful of colleges now get disqualified each year because of excessive loan-default rates may suggest that particular measure isn't too strict, Mr. Madzelan said.

For some institutions, though, the threat is worrying. The practical-nursing program run by the Board of Cooperative Educational Services in the New York counties of Madison and Oneida saw its default rate surge from 16 percent under the two-year measure to 43 percent under the three-year window, according to the Education Department data.

The publicly operated program, with about 160 students paying $7,800 for an 11-month course, is the only school in the two counties producing licensed practical nurses, said Richard W. Mitchell, the board's director of health occupations. Many of the school's students have been single mothers forced to drop out because of family crises, such as the loss of a child-care provider, Mr. Mitchell said.

The school, however, works out whatever financial arrangements it can manage to help keep its students in class, and it doesn't pursue collections against any of them, he said. "Our philosophy," Mr. Mitchell said, "is that everyone deserves a chance."