December 2, 2007

Is the “official” default rate meaningless?

Posted in Legislation Affecting Students at 7:59 AM by Joe From Boston

Inside Higher Ed has a very interesting new article on the official default rate used by the Department of Education, called the cohort default rate. Historically, the cohort default rate was calculated to avoid banks screwing over students, but the claws were taken out of this law ten years ago… Read the excerpt below, or the whole article here.

A More Meaningful Default Rate

The Education Department’s “cohort default rate” — the rate at which student loan borrowers default within 12 to 24 months after they leave college — was initiated in the late 1980s largely to draw attention to institutions seen as preying on low-income students who may struggle to repay their loans. But changes Congress made in 1998 to how the rate is calculated have rendered it a far less useful indicator either of students’ indebtedness or of colleges’ malfeasance, numerous government and other reports have agreed in recent years.

An amendment attached to House of Representatives legislation to renew the Higher Education Act this month is designed to make the cohort default rate a more realistic assessment of how individual institutions (and lenders) are faring in keeping student borrowers on track to repayment, extending to three years from two the period over which borrowers’ defaults are measured. The change, if it becomes law, is likely to significantly raise most colleges’ default rates, which could cause problems for institutions that have historically had higher rates of student loan default — most notably for-profit career colleges, but also some two-year and historically black colleges.

“Extending it by a year should give us a more accurate assessment of what’s going on,” Rep. Timothy Bishop (D-N.Y.), who co-sponsored the amendment with Rep. Raul Grijalva (D-Ariz.), said in an interview this week. “If because of it there are more schools that now fall into an area where there’s a red flag, that are encroaching on a problem, that’s a good thing.”

The idea was that abnormally high default rates would signify a low-quality institution that was failing to prepare students for work and life, and that holding colleges accountable for the rates at which their students defaulted on loans — threatening loss of access to federal grant and loan funds for institutions whose rates exceeded 25 percent in three successive years or 40 percent in one year — would weed out fraudulent schools and force other institutions and lenders to take the issue of student debt more seriously.

In many ways, the idea worked — hundreds and hundreds of “fly by night” trade schools, as they were unfailingly referred to, shut their doors by the early 1990s after having lost their eligibility for federal aid because of their default rates. And through a series of practices adopted by colleges, lenders and governments, default rates fell throughout the 1990s.

Linking Defaults and College Quality

…some college leaders bristled at the link the government had made between default rates and institutional quality. Officials at for-profit colleges and, to a lesser extent, community colleges, argued that while the default rate provisions had appropriately helped kill off poor quality colleges, it had also endangered legitimate institutions that served large numbers of low-income students who needed loans to pay their college bills.

…in the 1998 Higher Ed Act bill, Congress altered the cohort default rate calculation by extending, to 270 days from 180 days, the amount of time before the federal government deems a delinquent borrower to be in default. That change delayed the point at which the government must take responsibility for a bad loan and repay the bank that made the loan, saving the U.S. Treasury money. But it also had the effect of making it easier to postpone a student’s potential default, raising questions about whether colleges might be encouraging borrowers to seek deferments or forbearance from lenders, since students in those situations are not in danger of defaulting.

“The default rate is a snapshot, and with a two-year rate and a 270-day window, it became easier to smile for the picture and then be beyond the window,” said Robert Shireman, executive director of the Project on Student Debt.