Will Holding Colleges Accountable for Default Rates be Effective?

As student loan debt continues to climb and Congress enters a midterm election year, three Democrats in the United States Senate (Reed, Durbin, and Warren) recently introduced a piece of legislation designed to hold certain types of colleges and universities accountable for their students’ loan default rates. If enacted, the bill would require colleges to pay a fine of a percentage of its students’ total defaulted loans to the Department of Education, part of which would be used to help borrowers avoid future defaults and the other part would go to a fund to help support the Pell Grant in case of any future funding shortfalls.

The proposed fines are the following:

  • 5% fine if the most recent cohort default rate (CDR) over three years is 15-20%
  • 10% if CDR is 20-25%
  • 15% if CDR is 25-30%
  • 20% is CDR is 30%+

As an example of what these fines could mean, consider their potential implications for the University of Phoenix’s online division. Data from the Department of Education’s Integrated Postsecondary Education Data System (IPEDS) show that Phoenix collected roughly $1.4 billion in student loan revenue during the 2011-12 academic year, while 34.4% of students who took out loans defaulted in a three-year period. This default rate would place them in the 20% fine category, resulting in a fine of roughly $100 million per year based on an estimated $500 million per year in defaulted loans. This would represent roughly four percent of their total tuition revenue ($2.7 billion) in the 2011-12 academic year—which is far from a trivial sum.

Daniel Luzer on Washington Monthly’s College Guide blog (where many of my pieces are cross-posted) notes some of the potential positives of this legislation, including encouraging colleges to spend more time and energy counseling students and providing more information about financial aid.

But, in order for this legislation to actually benefit students, three things must happen:

(1) Some colleges must actually be affected by the legislation. The sanctions in the bill would not apply to community colleges, historically black colleges and universities (HBCUs), and likely other colleges designated as minority-serving institutions. This excludes a substantial number of nonprofit institutions, many of which have higher default rates. A provision in the bill excludes colleges at which fewer than 25% of students take out federal loans, which further diminishes the number of nonprofit institutions on the list.

But even if a college is not exempt from the legislation, it is still possible to avoid fines if default rates are over 15%. The legislation grants the Secretary of Education the authority to grant waivers, which would be the first time the Secretary has ever been granted that authority. (Kidding!) Colleges can submit remediation plans in order to avoid or reduce fines. It will be interesting to see the reaction to the first waiver request, as colleges’ lobbying efforts tend to be well-organized.

A more interesting case will involve the for-profit sector. Given the three Senators’ general distrust of for-profit institutions, it would not surprise me if nearly all of the colleges facing fines are proprietary in nature. But the way the bill is targeted seems to be similar to previous attempts at gainful employment legislation, which have been the subject of massive amounts of litigation. Expect this proposal to face litigation if it ever became law.

(2) Colleges must be able to improve their financial aid offices without restricting students’ access to financial aid. One of the underlying premises of this legislation is that financial aid offices are not helping students make sound financial decisions that help them complete college. Aid administrators would likely disagree with that statement, although additional resources targeted toward financial counseling may be beneficial.

Another concern is that in order to reduce default rates, aid offices will not offer students loans if they perceive the student as having a higher risk of default. While there is a prohibition written into the legislation against denying loans based on the perceived risk of default, this would be extremely difficult to prove and enforce. Colleges are not required to offer students the full amount of loans available in the initial aid package, and indeed some community colleges decline to offer any federal loans to their students. Some colleges would like more authority to limit loan offers to students, and this legislation could reduce access to credit for needy students.

(3) The legislation must adequately address students who transfer. If a student takes out loans while attending multiple institutions, would each college be held responsible for a student’s default—even if most of the debt was at one institution? Consider a student who attends a regional public university for one year and takes out the maximum in subsidized Stafford loans ($3,500). She then transfers to an expensive private college and accrues an additional $30,000 in debt before graduating. If she defaults on her principal of $33,500, should both colleges be held responsible? That is unclear at this point.

So would holding colleges accountable for default rates (in the method of this legislation) help students? I’m skeptical because I don’t see many colleges actually facing sanctions, nor do I see the fines being particularly effective. This is one of those ideas that is great in theory, but may not work as well in practice.

I don’t think this legislation is likely to become law in its current form, but it’s worth keeping an eye on as the Department of Education works to develop the Postsecondary Institution Rating System (PIRS). Many of the potential discussions this legislation raises will certainly come up again once the draft ratings are released.


About Robert

I am an assistant professor of higher education at Seton Hall University. All opinions are my own.
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