Why Colleges Are Starting to Worry About Student-Loan Defaults

More and more community colleges — arguably the most economical point of entry to higher education — are opting out of the federal student loan program. At last count, roughly 1 million students in 30 states are now scrambling for alternative financing.

According to a report by the Institute for College Access and Success, the schools are increasingly concerned about their cohort default rates, or CDRs — a calculation that divides the total number of students whose government loans entered repayment in a particular year (the so-called cohort year) and who defaulted on those loans later on, by the total number of borrowers who began to repay their education-related debts in that same cohort year.

CDRs are a big deal for all higher education institutions these days. That’s because schools with 30% default rates for three consecutive years — or those with greater than 40% in any one year — stand to lose their access to the various federal aid programs. The reason 2014 is of particular importance is because in 2008, Congress changed the look-back period to three years from two, beginning with loans that entered repayment mode in 2011.

As you might expect, those institutions that will no longer participate in the federal programs (including for Pell Grants) have taken to rationalizing that decision. Per the ICAS report, “…community college representatives typically cite their perceived inability to keep students from borrowing unnecessarily or to influence whether those borrowers repay their loans.”

Is that really the case? Are these schools truly insulated from the methods and management of the financing their “customers” require to be able to afford the “product” they’re selling? More pointedly, is it right for these institutions to take what amounts to a buyer-beware approach for a product as important as education?

The simple truth is that students are more likely to take on education-related debt when they and their families can’t cover costs that are debatably within the schools’ ability to control. Sure, the institutions would have to make difficult choices to control expenses, but those decisions are theirs to make, just as it is within the students’ and their families’ capacity to decide whether the product the schools are selling is worth the price.

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A Closer Look at What’s Driving Default Rates

That’s where a close look at educational outcomes comes into play, particularly the number of students who graduate and the quality of their post-college employment. The findings, however, are troubling.

According to a 2011 Harvard University study, the No. 1 reason approximately 50% of all college students fail to complete their studies is financial. And a 2013 Bentley University white paper notes that “…35% of business leaders give recent college graduates they have hired a ‘C’ or lower in being prepared for the job,” while “…66% of recent college graduates say unpreparedness is a real problem among their own cohort.”

It would be easy to say that if higher education were more affordable and professionally effective, repayment rates would improve. But that’s not all that’s driving student-loan default rates.

Given the significant amount of indebtedness that recent graduates have undertaken (more than 70% owe an average $33,000 upon graduation) and where borrowers of more than one-third of all loans that are currently in repayment mode are struggling to keep up, it’s hard to understand why these loans continue to be structured with 10-year durations. Debts that are the size of small mortgages should have longer repayment terms. The government knows that, but for some reason offers extended durations only to borrowers who are in distress.

What I find even more troubling is that the CDR is based upon debts that have not been paid for nine months or more. This is, in and of itself, mindboggling to anyone with loan-servicing experience. Borrowers who miss a couple or three payments can more easily be rehabilitated than those who are permitted — I use that word deliberately — to miss more. Clearly, the loan servicing companies are as much to blame for student loan default rates as anyone.

Meantime, where does this poorly conceived and narrowly rationalized decision on the part of the community colleges leave students who are now without access to the government’s low-cost education-financing programs? In the higher priced, less-accommodating hands of the financial services industry.

Get ready for even higher default rates.