Call it one of the dirty little secrets of the education industry: When students can’t pay their loans, many schools manage (some would say, manipulate) default rates so they look better than they really are.
Without a doubt, it would appear the practice has been far more prevalent among beleaguered for-profit schools than not-for-profits.
Based on my discussions with industry insiders and multiple analysts who have tracked the industry for years, here’s how it works:
How it Works
To qualify to provide federal student loans and grants, schools need to keep their so-called “cohort” default rates below a certain level.
The cohort default rate measures students who default within one to two years of entering repayment. A loan isn’t considered in default until 270 days after a payment has been missed. For years now, according to the Higher Education Act, school are at risk for losing federal aid if defaults exceed has been 25 percent for over two years; that’s in the process of shifting to 30 percent over three years.
To make sure they don’t exceed those limits, the schools contract with companies that specialize in “default management,” which is encouraged by the Education Department as a way to help students.
To many schools, however, it appears “default management” is really a euphemism for making sure default rates don’t exceed those statutory limits in the first two (and now three) years after a student gets a loan.
“Unlike the counseling process with other forms of credit, there is no evidence that institutions are interested in encouraging students to restructure their loans so that they can make at least some level of principal payments,” says analyst Bradley Safalow of PAA Research, who has tracked for-profit schools for nearly a dozen years.
If a student isn’t paying, they’re likely to get a call from a company like General Revenue Corp., a division of Sallie Mae, or Wright International Student Services, which specialize in “default management solutions.”
(Wright did not respond to our request for an interview.)
Every Student ‘Worked’
According to Wright’s website, the company has been successful in bringing down default rates for schools to an average of around 5 percent from over 20 percent. It charges $5 to track a student for two years; $80 if the student is brought current, forbears or defers.
“Every delinquent student is worked until we are successful or the student defaults,” the company says on its website.
If that isn’t clear enough, on another page of the website the company says, “We will track these accounts until the cohort is over.”
In other words, based on the company’s promotional material, it appears students who have defaulted are tracked only as long as they can hurt a school’s default rate.
Wright claims in a video on its website that it currently services 300 schools with 50,000 student accounts.
But this much is clear, Education Undersecretary James Kvaal told me: “We would be concerned by the use of deferments and forbearances in a manner that leaves borrowers less able to repay their loans, but would delay any default until after the two-year window used to measure school default rates.”
Default Management Calling
According to analysts, typically when a default-management firm calls:
The first objective is to get the student to pay. But the person isn't paying it usually means he or she doesn't have a job or don’t make enough money to pay the loan.
If either is the case, the next goal is to convince the person to either defer the loan for two years or put the loan into forbearance—two tools offered by the government. The difference between the two is that with forbearance, interest is owed and accrues during the period payments aren’t made. With a deferral, interest on subsidized loans doesn’t accrue.
If the student doesn’t qualify for either, the company may push for a repayment price based on income. (The end result tends to be a higher interest rate than traditional payments.)
If all else fails—and the student is still taking classes—the choice might be to consolidate a defaulted loan into a new loan, which resets the default clock.
Kicking the Can
There are variations on the theme, but the result is the same.
“They’re just kicking the can down the road past that window,” says Mark Kantrowitz, publisher of FinAid.org, which is focused on student loans. “Students are still ultimately defaulting.”
To be sure, defaults have been on the upswing, after bottoming at 4.5 percent in 2003. According to the Education Department, the 2008 national cohort default rate (the most recently measured) rose to 7.0 percent from 6.7 percent. For-profits were the worst, jumping to 11.6 percent from 11 percent.
What The Schools Say
Here’s where it gets interesting:
According to figures compiled by Education Department based on 2007 cohort default rates—the latest available for comparison purposes—three-year default rates for for-profit schools almost doubled to 21 percent; rates at not-for-profits rose by about two-thirds to 9.7 percent.
“There’s a possibility schools are managing their default rates based on the dramatic increase is in the three-year rate over the two-year rate,” says FBR Capital Markets analyst Matt Snowling, who has tracked the student loan industry for at least ten years.
FBR shows the risk hitting the new default threshold of 30%, as the window is stretched to three years, is considerably worse at for profits than private colleges.
Perhaps the most striking is Corinthian Colleges , whose three-year rate leaped to 29.3 percent—perilously close to the new threshold—from 14.6 percent.
It’s the Economy, Stupid
Like other schools we spoke with, Corinthian attributed the higher default rate in the third year to the longer window.
“In virtually any kind of loan, the longer the repayment period, the more people are likely to default,” a spokesman said. “This is particularly true in student loans."
He added: “We have representatives who work with our grads when they fall behind in payments; we try to find out why and see if we can help them find a way to get current or help them qualify for programs that provide some relief. Under the current rules, we’ve been working with grads for a two-year period; under the new rules, we’re extending that period to three years. But right now grads in the third year haven’t had any assistance, so they’re even more likely to default. As we work with them, we can bring the default rates down.”
Meanwhile, Snowling notes that 2007 default rates “are based on students that went into repayment back in 2007 before the economy imploded. So as the 2008, 2009 and 2009 cohorts entered repayment things only get worse.”
And while none of this really matters unless default rates pass the default threshold, Snowling adds, “The actual default rates are even higher. So the bigger question is: How defendable is a program that may have 50%-plus defaults. If the ‘economy’ can’t support these students with jobs, then why are schools growing enrollment?”
P.S.: To get around default-rate manipulation, the Education Department’s proposed gainful employment rules focus on repayment rates and debt-to-income ratios – not default rates -- to determine federal aid eligibility. The new rules are expected to be enacted next month. But the for-profit industry is pushing hard to have them watered down or blocked. Game point.