Why Default Rates Aren't Enough

The US Department of Education recently announced that ten colleges could lose eligibility to accept some or all federal financial aid. That’s because current law requires that the share of  borrowers leaving a college who default on their student loans within three years (known as the cohort default rate, or CDR) cannot exceed 30% for three consecutive years or 40% for one year. While these ten colleges may face immediate consequences for surpassing one or both of these conditions, many others have only narrowly evaded trouble.

Unfortunately, the institutions just under the threshold that Congress set are not necessarily preparing students any better than those with a default rate that exceeds 30%. With major consequences tied to a school’s three year CDR and no institutional accountability for a borrower who defaults later, there’s a strong incentive for schools to game the system. By encouraging borrowers to pursue federal protections like forbearance and deferment -- both of which may delay repayment until they have safely cleared the three-year window -- colleges can easily avoid punishment.

Thankfully, there is an alternative measure known as the repayment rate. The repayment rate captures the percentage of student loan borrowers whose outstanding debt today is less than the amount they borrowed. That’s a much stricter standard than the CDR, in which students who are using forbearance, deferment or income driven repayment but are not making progress on their principal loan balance are all considered in “good standing.” In contrast, to count under a college’s repayment rate, borrowers must actively be paying down their loans faster than interest accrues.

It turns out that the two measures are not as closely related as one might assume, especially around the threshold where it matters most.

It turns out that the two measures are not as closely related as one might assume, especially around the threshold where it matters most. Many colleges that fly under the radar with relatively low cohort default rates also have lackluster repayment rates. At the same time, a rule that uses the repayment rate as a baseline in lieu of the CDR may actually absolve some of those in trouble for their high default rates.

 The American College of Healthcare in Huntington Park, California had a CDR just under 17% last year, well below the level that would trigger federal sanctions. But shockingly, only 15% of the college’s students had made any progress on their principal loan balance three years after leaving. This means that a full 85% of borrowers are not repaying their loans, but the school has faced no repercussions. 

If Congress were to simply swap the default rate for the repayment rate as a measure of institutional quality, 122 colleges that avoided any consequence last year could face sanctions for having a repayment rate below 30%. This number would rise to 363 if the repayment threshold was set at 40%. Meanwhile, almost 20 colleges who violated the CDR rule last year could breathe a sigh of relief.

For instance, Aaron’s Academy of Beauty in Waldorf, Maryland has had a default rate above 30% for the past three years. As such, it is one of the ten schools that the Department suggested could soon lose access to federal financial aid. But while its CDR in 2015 was dangerously over the 30% mark, it’s three year student loan repayment rate was 42%, which is better than over 360 colleges that have lower default rates. With 58% of borrowers not paying down any principal on their loans at the school, Aaron’s repayment rate is certainly no cause for celebration. Nonetheless, the notion that a college, which performs better on a stricter measure of borrower success, may still fall prey to the arbitrary CDR rule confirms its ineffectiveness.   

Aaron’s Academy isn’t alone. In 2015, 51 colleges with a CDR that exceeded 30% also had a repayment rate above 30% and 19 had a repayment rate above 40%. At the same time, over a quarter of the colleges on the cusp (those with a default rate between 25 and 30 percent) failed to meet these same criteria. Even worse, almost 300 colleges with a CDR further from the threshold, between 0-25%, had a repayment rate below 40%.

Using the repayment rate instead of the CDR as a measure of institutional quality would mean many more colleges could lose eligibility to accept federal aid. But the CDR has not only failed to weed out institutions that are not serving their students. It also occasionally punishes colleges that have better repayment outcomes than many others. While certainly not all with a high CDR deserve a pass because of their slightly better repayment rates, the imprecision of the current rule demonstrates why default rates aren’t enough.