Trouble Ahead on Student Loan Defaults

WASHINGTON -- The U.S. Education Department announced late Friday that the rates at which student loan borrowers defaulted on their loans had spiked in 2009 -- and one leading analyst projected that the rise could foreshadow significant (additional) problems for for-profit colleges, where the rates grew most sharply.

In a news release issued Friday afternoon announcing draft cohort default rates, William J. Taggart, chief operating officer of the department's Federal Student Aid office, said that 8.9 percent of federal student loan borrowers who entered repayment between October 1, 2008, and September 30, 2009, had defaulted by September 30, 2010, up from 7.0 percent the year before. That rise -- of 27 percent -- nearly equaled the largest percentage increase in loan default rates since the Education Department began tracking them in 1987; that increase occurred just two years ago, when the rates rose to 6.7 percent from 5.2 percent.

While rates rose for all three major sectors of higher education, the growth was driven particularly by an escalation in the number of defaults involving borrowers from for-profit colleges.

Students from for-profit colleges, who make up about 12 percent of all undergraduate students, made up about 27.7 percent of federal student loan borrowers who entered repayment beginning in October 2008. Yet they made up nearly half (47.4 percent) of all borrowers who had defaulted on their loans within two years of entering repayment.

In all, 15.2 percent of borrowers from for-profit colleges defaulted on their loans within two years. That's an increase of 31 percent over 2008, when 11.6 percent of for-profit college borrowers defaulted.

Students at public institutions made up nearly half of all borrowers (49.4 percent) and about 40 percent of all defaulters, while students from private nonprofit colleges made up 22.6 percent of borrowers who entered repayment and 12.1 percent of defaulters. The default rate for public college borrowers was 7.3 percent, and for independent colleges, 4.7 percent.

If the two-year default rates look troubling to for-profit college officials, the numbers are likely to be significantly worse as the Education Department continues its transition to a default rate measure that tracks borrowers for three years after repayment begins. When the agency published its last trial set of three-year rates in February, covering fiscal year 2008, they more than doubled the official two-year rates across the board.

That led Mark Kantrowitz, publisher of FinAid.org and a leading analyst of financial aid and student loans, to project that the average three-year default rate for for-profit colleges is likely to approach the 30 percent threshold at which institutions could see their access to federal financial aid threatened beginning in 2014, when the Education Department formally begins using the three-year default rates as its measure (see table below).

That is especially so, Kantrowitz suggested, in the context of pending federal rules designed to ensure that vocational programs prepare graduates for "gainful employment" in a relevant field. If the new version of those rules -- which the Education Department is weeks if not days away from releasing -- is largely consistent with the earlier iteration, they will punish colleges not just for borrowers who have defaulted on their loans, but also for those who are delinquent or have deferred repayment of the loans. "Shifting default management efforts from deferments and forbearances to the various repayment options" to comply with the gainful employment regulations, Kantrowitz said, "may lead to an increase in default rates even if these efforts are carefully targeted at high risk borrowers."

Though Kantrowitz acknowledged the possibility that the 2009 default rate figures may represent a "high-water mark" because that's when the economy was at its worst point, he suggested that peril may lie ahead for for-profit institutions on default rates.

Projected 3-Year Cohort Default Rates, by Sector

Source: Finaid.org