Lowering Student Loan Default Rates

What One Consortium of Historically Black Institutions Did to Succeed

Reports & Briefs | February 19, 2010
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Colleges across the nation are struggling to confront a growing problem in higher education: student debt. As more students borrow more money than ever before, and recent graduates enter the worst job market in a generation, students are increasingly unable to pay back their loans.

At a recent conference in Austin, TX, financial aid officers representing a wide variety of institutions shared secrets to combating this problem. Some of the tactics were unorthodox: perfumed envelopes, colored Easter bunnies and Valentine's Day hearts, brightly colored paper with the words "CHECK INSIDE" stamped on the outside. But they worked—helping colleges successfully reach out to delinquent student borrowers.

For some of the conference participants, the discussions had a familiar ring. Just over 10 years ago, a small group of historically black colleges and universities (HBCUs) in Texas confronted a similar crisis, one in which student loan defaults threatened the existence of the institutions. The steps they took to solve that problem have suddenly become relevant to a much broader set of colleges and universities today.

The problem, then and now, starts with a number called the "cohort default rate," which is calculated annually by the U.S. Department of Education for every college and university in the country that participates in the federal student aid program. The rate is the percentage of student borrowers who default (defined by the department as not making loan payments for 270 days) within two years of leaving school. The federal government uses the cohort default rate to sanction colleges where too many students don't pay back their loans. Any college with a rate higher than 25 percent for three consecutive years or above 40 percent in any one year risks losing eligibility for federal student aid. Without access to federal grant and loan funds to help students pay tuition, a school's very survival is at risk.

The average default rate has hovered around 5 percent since 2001, leaving most colleges far below the danger zone. But a number of things have happened in recent years to put substantially more colleges at risk. Rising college costs have forced students to borrow increasingly large amounts of money, sums that are more difficult to pay back. The latest cohort default rates, which track students who left school in 2007, showed the largest increase since 1989, with 6.7 percent of students defaulting on their federal loans. The classes of 2008 and 2009 face bleak job prospects, putting more students at risk of defaulting and suffering its consequences-ruined credit and mounting debt from accumulated collection fees and unpaid interest.

At the same time, Congress has raised the bar for institutions. 2008 saw the reauthorization of the massive federal Higher Education Opportunity Act (HEOA). Provisions in that legislation mandate that, starting in 2014, colleges will be held accountable for the percentage of students who default within the first three years of leaving school instead of just two years. A recent Department of Education analysis found that 2007 cohort default rates jumped from 6.7 percent over two years to 11.8 percent over three years, a 76 percent increase. And despite the fact that the legislation increased the default threshold from 25 percent to 30 percent, the extended time frame will put many more schools at risk of facing sanctions. In 2009, only two schools faced sanctions under the existing two-year calculation. But under the proposed three-year calculation, over 50 schools would be at risk.

Most at risk are those schools that serve large numbers of first-generation and low-income students. These populations, which are at a higher risk of dropping out and are less likely to have family resources to rely on, are more likely to default. As such, those schools that serve them will find it harder to keep their cohort default rates below the federally mandated cut-offs, rendering them at greater risk of crossing the default rate threshold and losing eligibility for financial aid. Among for-profit institutions, for instance, default rates nearly doubled, growing from 11 percent to 21.2 percent. HBCUs as a whole saw a 60 percent increase, from an 11.6 percent average default rate to an 18.5 percent default rate, with 10 institutions having default rates above 30 percent and several more coming close.

But the experience of the Texas HBCUs, along with a new statistical analysis of cohort default rates, suggests that dangerously high default rates for institutions that serve at-risk students are not inevitable. From the initial financial aid package to providing individual counseling on loan repayment when students leave, institutions can take steps to help students avoid default. Schools can also maintain contact with students after they leave campus, communicating with them about when they need to begin repayment and where they should send their repayment checks. And for some schools, personal tactics like perfumed envelopes and holiday-themed mailings are especially effective in keeping students out of default.

Such "default aversion" strategies helped a number of HBCUs significantly lower their loan default rates and avoid losing eligibility for federal financial aid the last time the federal government imposed tough new default rate standards. Their story is one of teamwork, collaboration, and relationship-building and proves that when institutions are armed with the tools, resources, support, and commitment needed to lower default rates, they can do so successfully. With the recent HEOA amendment and a worsening economic outlook, all colleges can learn from the efforts of these schools. Their success is not only applicable to other similar institutions, but to all schools that serve those students most at risk for default and who are committed to helping them succeed.

Default aversion strategies, moreover, are just one part of the solution. Institutions that make increasing graduation rates a priority will also help their students repay their student loans. Put simply, students who graduate are less likely to default. As institutions face the next default rate challenge, those that combine default aversion strategies with strategies for degree completion will be in the best position to not only reduce their default rates now and in the future, but to improve the overall success of their institutions and their students.

Education Sector thanks Lumina Foundation for its support of this project. Lumina Foundation for Education is an Indianapolis-based, private foundation dedicated to expanding access and success in education beyond high school. The views expressed in this report are those of the authors and do not necessarily represent those of Lumina Foundation for Education, its officers, or employees.

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