Student Loans II: How Much Default?

What is an acceptable level of loan default?

College and university leaders will be increasingly called to answer this question. That’s partly because the law will demand it: the newly embraced three-year cohort default rate measurement could result in penalties for more colleges and universities, and recent Congressional proposals could make institutions where significant numbers of students borrow and default on those loans responsible for paying back a sliding-scale amount of the defaulted debt to the federal government.

But the federal government’s current mechanism for holding institutions accountable for default rates has significant shortcomings.

The federal bar for monitoring loan default is necessary, but not sufficient for a number of reasons.

First, the cohort default rate does not account for institutions with high numbers of risky borrowers. To address this, the Institute for College Access & Success has proposed a Student Default Risk Index, which takes into account the proportion of students who borrow at an institution (unlike traditional cohort default rate calculations) in determining an acceptable risk of default.

Second, the threat of federal sanctions may create disincentives for institutions to provide their students with access to federal loans. Recent headlines provide anecdotal evidence that some community colleges prefer to limit access to loans in order to preserve Pell eligibility for students.

Third, federal sanctions do not address private student loan default. According to a report released by the Consumer Financial Protection Bureau, the agency estimated private student loan debt to stand at $165 billion at the end of 2011.

Finally, the threshold for sanctions is relatively low and it remains to be seen how many institutions will actually be sanctioned.

For those reasons, we think it is important for those of us in higher education to extend our discourse about default above the bar set by federal policy.

Given these limitations, we recommend institutional leaders approach debates about default from the following three perspectives.

(1) Institutions might approach the question from a mission-focused perspective. If we assume that the core mission of any educational institution is to maximize the educational attainment of its students, then questions about loan default should be tied to understanding how the prospect of borrowing, indebtedness and repayment affect important outcomes like learning, academic achievement, persistence, and completing a credential.

These are important questions for at least two reasons. First, loans are intended to serve as policy tools to help students obtain an education. In light of a public policy shift toward the preference of loans over grants and the continued decline of public investment in postsecondary education, it is important to frame the default debate in terms of educational outcomes. Second, a key predictor of repayment hardship and even default is whether or not a student completed their program of study and earned a credential. If we hope to help struggling borrowers repay loans, it seems clear that the best policy solution is to help students graduate.

(2) Institutions should consider the question from a political perspective in terms of public stewardship (more so than politicking). Default has clearly captured media and public attention. From our perspective, this is because debt is part of broader social debates about college affordability, economic opportunity and social mobility.

Perhaps it is no accident that this current debate (it is cyclical) comes on the heels of the greatest period of economic turmoil and insecurity since the Great Depression. Following on the heels of the Great Recession, debt has increased because more people went back to school and because income has fallen. Politicians and policy makers are seeking to assuage the concerns of constituents through a number of proposals.

The Wisconsin state legislature proposed the “Higher Education, Lower Debt” bill that would have created a new state agency to refinance student loans. Oregon’s “Pay It Forward” pilot program would use a graduate tax rather than loans to finance college, while Senator Marco Rubio (R-Fla.) proposed a plan that would have investors pay students’ tuition in exchange for a share of their future earnings.

In debating potential changes to financial aid policies, institutions should consider the relevance of public perception and the reaction of elected or appointed policy makers. It may be tempting to cynically evaluate proposals from ill-informed politicians whose solutions are loosely (if at all) coupled to the problem of student loan debt. However, it is important to take seriously the underlying concerns that drive the current rhetoric. In crafting an institutional plan, acknowledge these concerns as much as possible among the various constituents (e.g., students, parents, politicians, news media). Ultimately, political and policy questions are about the perceptions of the community that the institution calls home. It is vital that higher education leaders engage these perceptions.

(3) Institutions should consider engaging in philosophical reflection. Embedded in the question, "What is a reasonable amount of default (and by extension debt)?" are beliefs about who should pay for the benefits and burdens of education. If we believe education only benefits the individual, then asking students to foot the bill themselves via loans makes sense.

Conversely, if we believe education benefits the public primarily, grants would be the finance mechanism of choice. Over the past 20 years, federal education policy has moved toward viewing education primarily as a private good.

However, higher education in this country is extraordinarily diverse in terms of institutional mission and type. Institutions adopt varied approaches to student financial aid, in part because of different philosophies, missions, and resources. For example, Berea College has its Labor Program in which students contribute to the cost of their education by working, while Amherst College has a no-loan policy for its students and Johnson C. Smith University had 100 percent of its 2011 graduating class borrow to pay for school.

Institutions must be sensitive to their histories, needs and capacity when considering the question of student indebtedness. 

From the central administration office of a college to the day-to-day operations of financial aid offices, institutions are on the front line when answering the question, “What is an acceptable level of student loan default?” They are the last source of financial aid for students and it is their aid officers who do the bulk of consultation on borrowing and repaying loans.

Without clear and careful answers to this question, the current discourse around student loan debt and repayment crisis will leave little room for thoughtful solutions. At a minimum, answering this question should account for the academic, political, and philosophical contexts outlined here. But answers should also be clear about the nature of the problem given the institutional context and the profile of students they serve.