Editor’s Note: On May 30, ABI hosted the Student Debt Symposium at Georgetown University Law Center in Washington. The day-long interdisciplinary conference brought together educators, policymakers and practitioners for a series of panels about the causes and consequences of the $1.2 trillion student debt bubble. Click here to access the video recordings organized by theme and topic: http://go.abi.org/student_debt_2014.
As the cost of college tuition continues to increase, so do the number of students taking on ever-increasing loans. More than 70 percent of college students leave an institution of higher education (IHE) in debt, and one of every seven borrowers falls behind in servicing their college loan obligations within three years of graduating or dropping out.[1], [2]
In April 2012, the Federal Reserve announced that American consumer debt is at an all-time high, with student loans leading the surge.[3] Currently, outstanding student debt is approximately $1.2 trillion, surpassing credit card debt as the second-largest form of consumer debt behind home mortgages,[4] and the default rate on federal student loans is approaching 15 percent,[5] with more than 7 million students in default on their education loans.[6] The average amount of a defaulted federal student loan is approximately $14,000.[7]
Many bankruptcy attorneys, including this author, believe that student loan defaults will be the next lending crisis that financial institutions and the federal government will face. The inability of borrowers to service student loan obligations “keeps them from being able to purchase homes, cars or other goods, which fuel our economy.”[8] Prompted by the current student loan crisis, Sen. Jack Reed (D-R.I.) introduced S. 1873 — the Protect Student Loan Borrowers Act of 2013 — on Dec. 19, 2013.[9] The co-sponsors of the Act are Elizabeth Warren (D-Mass.) and Richard Durbin (D-Ill.).[10] The Act was read twice and referred to the Committee on Health, Education, Labor, and Pensions.[11]
Understanding the Cohort Default Rate
The Act seeks to shift some of the burden of defaulted student loans to IHEs. To that end, the Act contains risk-sharing payment (i.e., penalty) provisions, but to understand those provisions of the Act, one must know what the term “cohort default rate” means. For an IHE having 30 or more borrowers entering repayment in a federal fiscal year (Oct. 1 to Sept. 30), the IHE’s cohort default rate is the percentage of its borrowers who enter repayment on certain Federal Family Education Loans (FFELs) and/or William D. Ford Federal Direct Loans (Direct Loans) during that fiscal year and default (or meet some other specified condition) within the cohort default period.[12] The phrase “other specified condition” occurs when, before the end of the cohort default period, the IHE or its owner, agent, contractor, employee, or any other affiliated entity or individual makes a payment to prevent a borrower’s default on a loan that entered repayment during the cohort fiscal year.[13] In such a situation, the borrower is considered to be in default for cohort default rate purposes.[14]
The cohort default rate is usually calculated for a two- or three-year period. In the two-year scenario, the period begins on Oct. 1 of the fiscal year when the borrower enters repayment and ends on Sept. 30 of the following fiscal year.[15] The three-year cohort default rate ends on Sept. 30 of the second fiscal year following the fiscal year when the borrower enters repayment.[16] For an IHE with 29 or fewer borrowers entering repayment during a fiscal year, the cohort default rate is an “average rate” based on borrowers entering repayment over a three-year period.[17]
On Oct. 28, 2009, the U.S. Department of Education (DOE) published in the Federal Register the regulations enacted by the Higher Education Opportunity Act of 2009 that will govern the calculation of cohort default rates.[18] Under the new provisions, an IHE’s cohort default rate is calculated as the percentage of borrowers in the cohort who default before the end of the second fiscal year following the fiscal year in which the borrowers enter repayment of their college loans (i.e., the three-year cohort default rate).[19] These provisions extended the length of time in which a student can default from two to three years.[20]
The Provisions of the Act
With an understanding of cohort default rates, one can begin to decipher the Act. The purpose of the Act is “to protect student borrowers by requiring institutions of higher education to assume some of the risk of default for student loans under part D of title IV of the Higher Education Act of 1965 (20 U.S.C. § 1087(a), et seq.).”[21] If enacted, Section 3 of the Act will amend Section 454 of the Higher Education Act of 1964 (20 U.S.C. § 1087(d)) to provide for an “institutional risk-sharing for student loan defaults.”[22] The “risk-sharing payment” will be applicable to each IHE participating in the direct student loan program under Section 454 for a fiscal year that has a rate of participation in such program for all students enrolled at said IHE for such fiscal year that is 25 percent or higher and require such IHE to remit, at such times as the Secretary of the DOE may specify, a risk-sharing payment based on a percentage of the volume of students that are in default.[23] The risk-sharing payments are set at:
- 20 percent of the total amount of its defaulted Direct Loans if its cohort default rate is 30 percent or higher;
- 15 percent of the total amount of its defaulted Direct Loans if its cohort default rate is lower than 30 percent but not lower than 25 percent;
- 10 percent of the total amount of its defaulted Direct Loans if its cohort default rate is lower than 25 percent but not lower than 20 percent; and
- 5 percent of the total amount of its defaulted Direct Loans if its cohort default rate is lower than 20 percent but not lower than 15 percent.[24]
The Act directs the Secretary to waive or reduce the risk-sharing payment if the IHE develops and carries out a student loan management plan, which must include an analysis of the risk factors correlated with higher student loan defaults that are present at the IHE and the actions that the IHE will take to address such factors.[25] A student loan management plan must include individualized financial aid counseling for students and strategies to minimize student loan default and delinquency.[26] An IHE that receives a waiver or reduction of the risk-sharing payment may receive a waiver or reduced payment for a subsequent fiscal year only if the Secretary determines that the IHE is making satisfactory progress in carrying out the student loan management plan.[27] IHEs are prohibited from denying admission or financial aid to a student based on a perception that such student may be at risk of defaulting on a Direct Loan.[28]
The Act establishes a separate account in the U.S. Treasury for the deposit of risk-sharing payments, of which (1) up to 50 percent may be used by the Secretary to enter into contracts or cooperative agreements for delinquency and default prevention or rehabilitation, and (2) the remainder shall be used to offset any future shortfalls in funding under the Federal Pell Grant program.[29]
The Act authorizes the Secretary to enter into contracts or cooperative agreements for statewide or institutionally based programs for the prevention of federal student loan delinquency and default at IHEs that (1) have a high cohort default rate or (2) serve large numbers or percentages of student loan borrowers who have a risk factor associated with higher default rates on federal student loans, such as coming from a low-income family, being a first-generation postsecondary education student, not having a secondary school diploma, or having previously defaulted on a Direct Loan.[30]
Conclusion
The Act seeks to hold IHEs with high student loan default rates on Direct Loans financially responsible for such defaults. It also incentivizes these IHEs to enact measures to decrease their cohort default rates. One has to wonder why the Act does not seek to hold financial institutions that make bad or non-underwritten student loans responsible for defaulted student loans, or whether such legislation could be in the offing. Outside of the student loan context, financial institutions feel the pain when business or consumer loans go into default. While the Act might be a game-changer for IHEs, it appears to be somewhat misguided.
[1] Karen Weise, “Putting Colleges on the Hook for Student Loans,” Business Week, Jan. 2, 2014, available at www.businessweek.com/articles/2014-01-02/a-bill-protect-student-borrowers-act-of-2013.
[2] See student debt infographic prepared by the American Bankruptcy Institute and Credit Abuse Resistance Education (“CARE”): http://care4yourfuture.org/student-debt
[3] “Commentary: A Vision for Reforming Student Loans,” ABI Bankruptcy Brief, Apr. 10, 2014, available at http://news.abi.org/briefs/commentary-a-vision-for-reforming-student-loans.
[4] Jennifer Grant and Lindsay Anglin, “Student Loan Debt: The Next Bubble?,” Am. Bankr. Inst. J., Vol. XXXII, No. 11 44 (December 2013).
[5] “Commentary: A Vision for Reforming Student Loans,” ABI Bankruptcy Brief, Apr. 10, 2014, available at http://news.abi.org/briefs/commentary-a-vision-for-reforming-student-loans.
[6] Grant and Anglin, supra n.3, at p. 44 (citing Rohit Chopra, “A Closer Look at the Trillion,” Consumer Financial Protection Bureau (Aug. 5, 2013), available at www.consumerfinance.gov/blog/a-closer-look-at-the-trillion/).
[7] Id.
[8] Erika Forero, “Bill to Hold Universities Accountable for Loan Defaults,” The Daily Cougar, Jan. 22, 2014 (quoting Richard Durbin, D-Ill.), available at http://thedailycougar.com/2014/01/22/bill-hold-universities-accountable-loan-defaults/.
[9] Protect Student Borrowers Act of 2013, S. 1873, 113th Congress (2013), available at www.gpo.gov/fdsys/pkg/BILLS-113s1873is/pdf/BILLS-113s1873is.pdf.
[10] Summary of S. 1873, available at http://beta.congress.gov/bill/113th-congress/senate-bill/1873.
[11] Id.
[12] Cohort Default Rate Guide, p. 2.1-1 (Sept. 2013), available at http://ifap.ed.gov/DefaultManagement/guide/attachments/CDRMasterFile.pdf.
[13] Id.
[14] Id.
[15] Id.
[16] Id.
[17] Id.
[18] Department of Educ., “Three-Year Official Cohort Default Rates for Schools, available at www2.ed.gov/offices/OSFAP/defaultmanagement/cdr.html.
[19] Id.
[20] Id.
[21] Act at § 2.
[22] Act at § 3.
[23] Act at § 3(d)(1).
[24] Act at §§ 3(d)(2)(A)-(D); see also supra at n.9, Summary of S. 1873.
[25] Act at §§ 3(d)(3)(A)-(B).
[26] Act at § 3(d)(3)(D).
[27] Act at § 3(d)(3)(C).
[28] Act at § 3(d)(4).
[29] Act at §§ 3(d)(5)(A)-(B)(ii).
[30] Act at §§ 4(d)(1)(A)-(B).