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A More Meaningful Default Rate

November 30, 2007

The Education Department's "cohort default rate" -- the rate at which student loan borrowers default within 12 to 24 months after they leave college -- was initiated in the late 1980s largely to draw attention to institutions seen as preying on low-income students who may struggle to repay their loans. But changes Congress made in 1998 to how the rate is calculated have rendered it a far less useful indicator either of students' indebtedness or of colleges' malfeasance, numerous government and other reports have agreed in recent years.

An amendment attached to House of Representatives legislation to renew the Higher Education Act this month is designed to make the cohort default rate a more realistic assessment of how individual institutions (and lenders) are faring in keeping student borrowers on track to repayment, extending to three years from two the period over which borrowers' defaults are measured. The change, if it becomes law, is likely to significantly raise most colleges' default rates, which could cause problems for institutions that have historically had higher rates of student loan default -- most notably for-profit career colleges, but also some two-year and historically black colleges.

"Extending it by a year should give us a more accurate assessment of what's going on," Rep. Timothy Bishop (D-N.Y.), who co-sponsored the amendment with Rep. Raul Grijalva (D-Ariz.), said in an interview this week. "If because of it there are more schools that now fall into an area where there's a red flag, that are encroaching on a problem, that's a good thing."

The cohort default rate was largely born of concern in the mid- and late 1980s about the explosion of trade schools, particularly in cities with large populations of minority and low-income residents, that were seen as trying to build their enrollments (and profits) by enticing academically underqualified students to apply for Pell Grants or guaranteed student loans that they were unlikely to be able to repay -- especially if they received a substandard education that did not lead to a good job.

The idea was that abnormally high default rates would signify a low-quality institution that was failing to prepare students for work and life, and that holding colleges accountable for the rates at which their students defaulted on loans -- threatening loss of access to federal grant and loan funds for institutions whose rates exceeded 25 percent in three successive years or 40 percent in one year -- would weed out fraudulent schools and force other institutions and lenders to take the issue of student debt more seriously.

In many ways, the idea worked -- hundreds and hundreds of "fly by night" trade schools, as they were unfailingly referred to, shut their doors by the early 1990s after having lost their eligibility for federal aid because of their default rates. And through a series of practices adopted by colleges, lenders and governments, default rates fell throughout the 1990s.

Linking Defaults and College Quality

But as the reauthorization of the Higher Education Act approached in 1998, some college leaders bristled at the link the government had made between default rates and institutional quality. Officials at for-profit colleges and, to a lesser extent, community colleges, argued that while the default rate provisions had appropriately helped kill off poor quality colleges, it had also endangered legitimate institutions that served large numbers of low-income students who needed loans to pay their college bills.

In part to respond to those complaints, but also to offset the costs of new programs and increased funds provided in the 1998 Higher Ed Act bill, Congress altered the cohort default rate calculation by extending, to 270 days from 180 days, the amount of time before the federal government deems a delinquent borrower to be in default. That change delayed the point at which the government must take responsibility for a bad loan and repay the bank that made the loan, saving the U.S. Treasury money. But it also had the effect of making it easier to postpone a student's potential default, raising questions about whether colleges might be encouraging borrowers to seek deferments or forbearance from lenders, since students in those situations are not in danger of defaulting.

"The default rate is a snapshot, and with a two-year rate and a 270-day window, it became easier to smile for the picture and then be beyond the window," said Robert Shireman, executive director of the Project on Student Debt.

Several government reports have echoed concerns that Shireman and other advocates for students had long expressed about the change in the default rate calculation understating some colleges' problems. A 2003 study by the Education Department's Office of Inspector found that the 1998 changes to the cohort default rate definition have "materially reduced schools’ cohort default rates, while threshold percentages for schools’ ineligibility have remained unchanged since 1994," the inspector general's report said. "For example, because the change in the definition of default increased the number of days it takes for a borrower to default, 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 report also found that the proportion of borrowers who sought deferment or forbearance more than doubled in the late 1990s.

A 2006 study by the Education Department's National Center for Education Statistics cited other flaws, which were analyzed in a report this fall by Education Sector, a nonpartisan research group. "The NCES study also found that, on average, defaults occurred four years following graduation -- two years longer than the Department of Education follows borrowers for its default rate calculations.... [T]racking students over the life of their loans provides important information on the total number of borrowers defaulting on loans and when those defaults are most likely to occur. The Department of Education's short, two-year time frame for tracking borrowers is especially misleading for students with the highest amount of debt. For those students, the two-year default rate looks comparable to the default rate for students with much lower debt levels. But, if you track defaults for three or more years, big differences emerge between these students."

Congress's Change

Those and other studies "show that the two-year window isn't the most accurate window," said Bishop, who spent 29 years as an administrator at the former Southampton College before entering Congress in 2002. Bishop said he, Grijalva and other House colleagues saw extending the window in which default rates were calculated by a year as a step toward better flagging "institutional problems" and giving lawmakers more accurate information about the extent of the effect of student loan burdens.

Another provision in the amendment -- which was among the recommendations of the 2003 inspector general's report -- would direct the Education Department to begin collecting and reporting information by college sector (two-year, four-year, public, private, for-profit) about defaults during the entire life of a loan, which some student aid experts say is how default rates should be calculated to begin with.

"I defy anybody to explain why we need to have any kind of window other than the entirety of loan life cycle," said Barmak Nassirian, associate executive director of the American Association of Collegiate Registrars and Admissions Officers. "In no other setting except student loans do we decide that a default that destroys a student shouldn't count just because it happened X many days after some window. We should move to a system where defaults count no matter when they occur."

The higher education groups that represent nonprofit colleges enthusiastically backed the Grijalva/Bishop amendment (and in fact reportedly played a major role in initiating it). That is despite the fact that while for-profit colleges are most likely to be affected by the change, some community colleges and especially historically black institutions could see their rates climb above the thresholds that signal potential risk for financial aid funds.

A review of the institutions with the highest default rates in 2005, based on the current calculation, shows the list heavily populated by relatively small career colleges, but also has community colleges like East Georgia College and Feather River Community College and historically black institutions like Livingstone and Voorhees College with rates in the upper teens. Given estimates that the addition of a third year to the cohort default rate window could raise average rates by 60 percent, that could put such institutions over the 25 percent line that can subject a college to trouble with the Education Department.

William (Bud) Blakey, who is Washington counsel for the Thurgood Marshall College Fund, which provides support to students at historically black colleges, said the group's members are "concerned about this, in part because we don’t know why you need to change the calculation to begin with." Blakey said he and others would work with House members to ensure that historically black institutions were not adversely affected by the potential change.

David S. Baime, vice president for government relations at the American Association of Community Colleges, said that while we "have some colleges that are going to be at the high end of default rates" if the new rate calculation becomes law, he believed most two-year colleges would qualify for exemptions in federal law that exclude institutions at which a relatively small proportion of students take on loan debt.

Baime said his group supported the amendment as an "important anti-abuse provision that will help provide a measure of integrity to the loan programs," adding: "Default rates have been the most proven mechanism to weed out the real rotten apples from the student aid barrel."

Officials at for-profit colleges are clearly concerned about the proposed change in the default rate policy, although they have had relatively little to say about the idea so far. "We don’t have a position yet," said Bob Cohen, a spokesman for the Career College Association, which represents most for-profit institutions. "We think a Congressional hearing may have clarified the need, if any, for such a change. In the short term, we are aware of no research to support such a need and are attempting to assess the possible impact of the change now."

If representatives of for-profit colleges are likely to feel that the proposed change is unnecessary or would go too far, others assert that the tweak in the default rate calculation, while a step in the right direction, is unlikely to make much of a difference

"I think we've gotten beyond the point where default rates are an effective tool for assessing school quality," said Shireman of the Project on Student Debt. "Going to three years instead of two is certainly better. But instead of fiddling around with that, we need the Department of Education, and probably accreditors, to get more sophisticated in how they assess school quality. They should be making sure students know that they're taking out loans instead of grants. Reviewing what happens when there are significant jumps in a school's loan volume," which can represent a change in how a college provides financial aid to students.

"Those sorts of things would identify problems early," Shireman said, "rather than waiting until default rates show a problem." By then, he points out, the affected students are already out of college.

 

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