The Default Trap

WASHINGTON – Advocates for community colleges are pressing federal lawmakers to make adjustments to a student loan law they say is a “blunt tool” that could unfairly penalize colleges where only a small portion of students default on their federal loans.

The U.S. Congress in 2008 expanded the window for tracking so-called “cohort default rates” to three years, up from two. As anticipated, that move resulted in higher institutional default rates.

Colleges face serious sanctions if they have a default rate of over 30 percent -- meaning 30 percent of federal borrowers default within three years of entering repayment -- for three consecutive years. The penalties will be imposed for the first time under the bulked-up measure after September, when the rates for 2011 are finalized. They include the potential collegewide loss of eligibility for all federal aid programs.

Congress tightened this rule with an eye on for-profit institutions, which tend to have the highest default rates. But community colleges have also been ensnared.

The sector’s overall default rate is up to 21 percent, according to the American Association of Community Colleges (AACC). And while only 19 percent of community college students take out federal loans, colleges can still face sanctions if they cross the 30 percent threshold.

“Obviously, we don’t want anyone to default,” J. Noah Brown, president of the Association of Community College Trustees (ACCT), said during a briefing Tuesday here on Capitol Hill. But “if left unaddressed, cohort default rates could lead to restricted access.”

Officials with ACCT said 15 community colleges had default rates of over 30 percent for the first two years under the new law (see box at right). And a handful of those colleges are wrestling with a draft rate for 2011 that is also over 30 percent. The draft rates are not final and have not been released publicly.

Frank Phillips College is one of them. The two-year institution, which is located in rural Texas, enrolls 1,200 students. It had a default rate of 31 percent in 2010 and 34 percent the previous year.

However, just 186 current and former students were on the hook for federal loans under the three-year window for 2010, according to federal data. Among that group, 58 were in default – hence the 31 percent rate.

Jud Hicks, the president of Frank Phillips, has said that if four students were able to continue paying off their loans for that year, the college would not be facing sanctions. But given that the draft rate is also over 30 percent, Hicks said, the college is potentially in deep trouble, and could lose federal aid eligibility.

Lane Community College, in Oregon, saw its default rate jump alarmingly in 2010. It hit 31 percent after being 20 percent the previous year.

A post-recession spike in enrollment, which was not matched by a comparable improvement in the job market for graduates, was behind much of that increase, said Mary Spilde, Lane’s president, who spoke at the event Tuesday.

“The jobs weren’t quite there yet,” she said, “even in nursing.”

Appeal and Adjust

Colleges that trip the rate threshold for three consecutive years can appeal to the feds to avoid facing sanctions. The appeal process includes features that are designed to prevent colleges from being punished when a relatively small number of students take out loans.

Lane had a draft rate of 30 percent for 2011. But the college filed a specialized appeal, and was able get to 29.7 percent.

The U.S. Department of Education's “participation rate index challenge” can be used for a college to avoid punishment, due to a low number of borrowers. It’s a complex tool, which basically moves the 30 percent default threshold based on whether the percentage of borrowers is below (or above) 21 percent. The fewer with loans, the higher the bar for punishment is set.

ACCT has called for a way to adjust the rates before colleges reach the risky point of a third-year challenge. This concept, dubbed a “student default risk index,” would work like the participation rate index's sliding scale.

The community college group last week released a report, jointly produced with the Institute for College Access and Success (TICAS), which included this recommendation.

The new index would “help ensure that federal aid dollars are spent wisely by more closely tying federal aid to the risk of students in enrolling and the risk to taxpayers in investing,” the report said.

The two groups also called for a smoother appeal process, under which colleges would not have to wait until hearing whether they had failed for three years before appealing. Other policy suggestions in the report included a push for automatically enrolling severely delinquent borrowers in income-driven repayment programs and for colleges to improve entrance and exit counseling for any student who receives a federal loan. (Note: this paragraph has been changed from an earlier version to correct an erroneous reference to the requirement for entrance and exit counseling.)

The report found that college completion is tightly correlated with default rates.

Community college students in the sample who successfully earned a credential had an average default rate of 9 percent. The default rate for dropouts, however, was 27 percent.

TICAS also recently released a study that tracked how many community colleges have voluntarily dropped out of federal borrowing programs in part to avoid the risk of default penalties and the potential loss of access to Pell Grants and other aid. The report found that 1 million students -- roughly 8.5 percent of the sector's overall enrollment -- do not have access to federal loans.

The consumer group has criticized community colleges that have made this move, arguing they should work with borrowers and the federal government rather than restricting aid to students.

AACC has a different solution, which TICAS opposes. The community college group has argued that access to Pell Grants for an institution's students should not be tied to the college's loan default rate. It is asking Congress to decouple Pell eligibility from that of federal loans.

Frank Phillips has tried to improve its default problems. It hired a default management consultant and has worked with students to help them repay loans, by informing them of repayment, deferment or forbearance options. The local economy has complicated that effort, however, as students continue to struggle to land jobs.

Likewise, Lane ended automatic packaging of unsubsidized loans for students. The college also required extra counseling for borrowers. But Spilde said those tools remain limited to prevent risky borrowing.

“We have very limited abilities to say no to students,” she said. “But at the end of the day we’re held responsible.”