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‘Skin in the Game’ on Loans

December 20, 2013

WASHINGTON -- A group of Senate Democrats announced Thursday a new push to provide student loan borrowers with more protections and hold colleges more accountable for loan defaults.

In a call with reporters, Senators Richard Durbin of Illlinois, Jack Reed of Rhode Island and Elizabeth Warren of Massachusetts highlighted a package of new and existing proposals aimed at reducing the burden of student debt. Durbin acknowledged that the senators had had “limited success” in getting Republican support for the measures, but said they will be a centerpiece of the Democratic agenda in the Senate in 2014.

One of the more controversial new proposals, to be introduced by Reed, would require colleges with high student loan default rates to pay a penalty to the government that is proportional to the defaulted debt.

Reed said the legislation is aimed at holding colleges more accountable for student loan defaults by having them share the risk of those defaults.

“They will have to have skin in the game,” he said. “They will have to make financial judgments based on how well-informed and how reliable their graduates are in terms of paying back their student loans.”

The concept of “institutional risk-sharing for student loan defaults” has previously been embraced, in a range of forms, by some student aid reformers, most recently in a February report by the Institute for College Access and Success.

Reed said that a sliding scale of penalties for colleges as their default rate increases or decreases would provide more direct and effective incentives to colleges than the existing all-or-nothing cohort default rate rules.

Currently, institutions are kicked out of the federal loan program if their two-year default rates are 25 percent or higher for three years or exceed 40 percent in any single year. The most recent national two-year cohort default rate across all sectors of higher education was 10.0 -- the highest since 1995. The department is transitioning to a three-year default rate for the upcoming year. (This paragraph has been updated to clarify the difference between the department's two-year and three-year default rates.)

Under the new proposal, a college whose student loan default rate reaches 15 percent or higher in a single year would have to begin to pay a penalty of 5 percent of the value of the outstanding defaulted debt. As an institution’s default rate increased, it would have to pay increasingly larger penalties, with a maximum repayment of 20 percent of defaulted debt for colleges whose default rates exceed 30 percent..

The money collected from institutions would be directed toward borrower relief and the Pell Grant Program.

The standards would apply only to colleges where more than a quarter of students borrow federal loans. And the bill also provides special exemptions for community colleges and historically black colleges, which recognizes those institutions’ “historic mission” of serving low-income students, Reed said.

Warren praised the risk-sharing proposal as good way to better-align “the incentives in the whole system.”

“This is not an indictment of every school out there,” she said. “Many schools are headed in this direction but there are many that are not.”

Reed’s proposal is the latest effort on Capitol Hill that has been targeted at holding colleges financially responsible for the outcomes of their students. Earlier this fall, two other Democrats introduced legislation that would base federal student aid on how colleges perform on certain metrics relating to access, affordability and value.

Similarly, a key component of the Obama administration higher education agenda in the coming years will involve lobbying members of Congress to allocate federal student aid based on how institutions perform in the college ratings system it is currently developing.

Other Changes to Student Loans

Among the other legislation that the Senate Democrats are pushing is a “student borrower bill of rights” that would increase disclosures to borrowers about their repayment options and their loan servicer. The legislation, introduced by Durbin last week, would also impose new requirements on how private lenders service loans and allocate payments.

In addition, the lawmakers plan to support a longstanding effort to make it easier for borrowers to discharge private student loan debt in bankruptcy and a new federal grant program aimed at creating incentives for states to chip in more money for higher education. 

 

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