Cohort Default Rates: The Good, the Bad, and the Ugly
Two weeks ago, we wrote in favor of a proposal to change how student loan defaults are calculated for the purposes of college accountability. We argued that lengthening the timeframe the government uses to measure student loan defaults could bolster everyone's ability to judge the quality of education offered by different institutions of higher education. Unfortunately, the House of Representatives seems to have caved to pressure from the trade school industry in particular and significantly weakened the proposal in ways that make it less useful. Today, we take a look at the good, the bad, and the ugly of the House's action.
For nearly 20 years, the U.S. Department of Education has kept track of the cohort default rates of every college that participates in the federal student-aid programs. The rates measure the percentage of students who have defaulted on their federal loans within two years of leaving college. For example, the 2005 rate reflects students who left school in 2005 and defaulted on their loans in 2006 and 2007. Borrowers who defaulted in the third year or later are not counted in the cohort default rates.
Schools with more than 30 individuals in a given repayment cohort are subject to sanctions if more than 10 percent of a cohort defaults. A default rate of 40 percent in a given year or 25 percent for three consecutive cohorts results in the school losing access to federal funds.
Large numbers of loan defaults from a specific institution of higher education can reveal that students are failing to complete degrees or classes (the largest general predictors of default) or are leaving an institution unprepared to meet the needs of employers. In fact, unemployment and low-paying jobs are reasons for default cited in one study by 59 percent and 49 percent of relevant borrowers, respectively.
Default rates have dropped precipitously over the last two decades. However, the Education Department’s own Inspector General has raised questions about whether the rate provides an accurate measure of student loan performance.
Among other things, Congress in 1998 made changes to the way the rate is calculated that artificially lowered the rate and made it a much less useful tool for the government to assess the extent of the student-loan default problem. That year, lawmakers 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.
Once that happens 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 a student loan will not be considered in default until roughly 420 days after their first payment was due. (The chart below shows this concept as a timeline).
Because it takes so long for a loan to go into default, the rate doesn't capture all the students in a cohort who leave school and default within the next two years. As a result of the change, a 2003 audit report by the Inspector General's report states, "some borrowers may not be included as defaulters in the cohort-default-rate calculation, even though they never make a payment on their loans and default at the first opportunity."
The House bill seeks to remedy problems caused by the 1998 change by extending the timeframe measured from two years to three years. We applaud this change because it would make the default rate calculation more accurate by including all students that default within the first two fiscal years, as Congress originally intended.
An even better solution would be to extend the default rate window to four years, which is not so long that students are completely divorced from their colleges, but long enough that they are starting to establish themselves in the workforce. But for now, the three-year window is at least a step in the right direction.
Under pressure from for-profit college lobbyists, the House agreed to raise the default rate threshold at which sanctions kick in. Previously, colleges could have their federal aid restricted if three consecutive cohorts had default rates above 10 percent or taken away if that figure exceeded 25 percent. Thanks to lobbying efforts by the Career College Association (CCA), an organization that represents trade schools, penalties would only kick in after three successive years above 15 percent and 30 percent, respectively.
The CCA claimed this greater leeway was necessary because schools that serve large numbers of low-income students — such as community colleges, for-profit trade schools, and historically black colleges and universities — are going to have higher default rates under the new window and could lose access to needed federal funds.
But allowing higher rates removes any incentive to tackle issues that may be causing high defaults, such as abysmal graduation statistics. Instead, it sends the message that it is ok for nearly one out of every three students to put themselves in a financial hole that could haunt them for the majority of their working life. After all, defaults only really hurt two parties: students, who have their wages garnished and credit tarnished, and taxpayers, whose money goes to pay back the student loan company. Schools, meanwhile, get their money up front, whether the loan is ever paid back or not.
As one final concession, the for-profit colleges won a one-year reprieve from the new regulations. The 2009 cohort, not the 2008 group, will be the first cohort to be measured under the three-year window. This means the new regulations will not take effect until 2012 at the earliest. This gives schools an unnecessary extra year to find ways to evade the sanctions.
The biggest failing of the House legislation though is that it does nothing to address the underlying issue of who is (or is not) counted in cohort default rates. As the IG report notes, students who either defer their payments or enter into forbearance can artificially lower a school’s default rate. This is because the calculation counts those students even though they are not actually making payments. Thus, if a school with 100 students in repayment has 10 defaulters and 25 individuals who have received deferments on their loans, the institution’s default rate is only 10 percent. Yet if the rate were calculated as the percentage of students defaulting who are actually making payments, the default rate would be 10 out of 75, or 13.3 percent.
Failure to fundamentally alter the cohort calculation, such as keeping track of how cohorts do through the lifetime of their loans or counting the students whose loans are in deferment as part of a cohort once they resume repayment, means that colleges will still be able to easily disguise how their students’ are doing in repaying taxpayer-supported loans over the long run.
Be warned: One of these days, conservative budget hawks are going to team up with progressive higher ed reformers on the default issue just as they did on student loan corruption. And when they do, the cohort default rate games aren't going to be so much fun for the proprietary school industry.