Changes in How Default Rates are Calculated at your College

The Congressional Budget Office has issued its estimate of the cost to the federal government of H.R. 4137, the College Opportunity and Affordability Act of 2007, as approved by the House Education and Labor Committee on November 15. This bill represents the House version of Higher Education Act reauthorizing. In contrast to the budget reconciliation legislation enacted in September (which was a cost cutting and spending bill), the HEA reauthorization is referred to as a policy bill.

According to the CBO, the bill (if enacted) would increase direct spending by $75 million in 2008 and decrease direct spending by $27 million over the 2008 to 2017 period. One of the “savers” in the bill is the change in the definition of “cohort default rate”. The bill includes an amendment offered by Congressmen Grijalva (D-AR) and Bishop (D-NY) that would revise the definition of cohort default rate by adding to the period of time in which a default is counted as part of a school’s cohort default rate.

Right now, a borrower default is included in the rate only if it occurs during the fiscal year when the installment loan enters repayment or the following year. The amendment would add one year to this period. Schools are subject to losing eligibility to participate in Pell and the student installment loan programs if their default rate exceeds 25% for three years. While no schools have been subject to this sanction in recent years that could change if the amendment were included in final legislation.

CBO projects that this change would reduce the number of schools eligible to participate in the student installment loan programs, thereby reducing direct spending by $27 million over the 2008 to 2017 period. Accordingly, all the net savings in the bill are attributable to the change in the cohort default rate definition.

The CBO cost estimate also points out that the bill reauthorizes and amends many of the discretionary programs, and creates new discretionary programs. Discretionary programs require annual appropriations. CBO estimates that implementing these programs would cost $97.4 billion over the 2008 to 2012 period.

Now We Jump Ahead to the 2012 period and Examine What is Happening in the Industry

First of all readers should understand that colleges who receive federal money to assist them in achieving their academic programs and fund students with student loans are measured and audited from time to time. One of the measures is the number of defaults by students within a specific period after they graduate. If the default rate is too high, the colleges could have their funding cut or other sanctions imposed that could curtail their funding and cause undue hardship on students as well as staff.

During the 2008 to 2012 period many graduating students had a very difficult time finding jobs and if they did find a job, many did not find well paying jobs. As a result they barely had enough to get buy to pay their day to day living expenses. As a result many of these students ended up defaulting on their student loans and push the default rate up at some colleges. These levels of default were dangerously high and in some cases were jeopardizing college grants and funding in a serious way.

Colleges responded in a number of ways.  The first and obvious way was to begin collection measures on many of their former students to recover some of the money, however when students who have graduated and are not working or working at minimum paying jobs, they cannot respond with payments. While they were successful at collecting funds from some students the over default continued to range dangerously high and still left the colleges in a difficult position.

The next approach, while not proven, is under investigation by the government and we are likely to hear a lot more about this process. Basically what the colleges did was to have employees in call centers track down and contact these ex-students and initiate a request to postpone their payments effectively placing these student loans in a different category and not technically in a default situation. For several years now the colleges have managed to stay within the government guidelines using this approach.

One wonders though, how many of these loans will actually be repaid and whether this process of suggesting to ex-students who have student loans to request postponement is ethical and whether it is within the intended laws that are on the books. In one opinion, the colleges are merely helping ex-students manage their financial situations instead of hiding from the creditor and ending up with a bad credit rating.

The past five years has been incredibly challenging for many companies and individuals on a financial level. This is just one more situation where colleges and regulators have been at odds with regards to how student loans should be administered.  We are still waiting to hear how this situation will reach a conclusion and wondering what other investigations may be going on where colleges are operating on the edge of what was intended by the law. Stay tuned for more to come in this area of student loans.