More Than 1 in 3 Federal Student Loan Borrowers Struggling to Make Payments

Behind the headlines and the "inside baseball" accounts of which lobbyists are talking to which members of Congress is this gnawing reality that the student loan reform discussion is missing one key constituent:  the struggling student loan borrower [Some are even going as far as to refer to student loans as the new indentured servitude] The headline may not be what you thought was the case after you saw the Department of Education's recent announcement about default rates.  After all, the number they announced for the 2007 cohort default rate (CDR) was 6.7%.  It got more interesting from there, as I dug further into those figures. 

First, I was surprised to discover that forbearances and deferments are included in the denominator for the CDR calculation. 

From studentaid.gov, here is the definition of forbearance:

"Forbearance is a temporary postponement or reduction of payments for a period of time because you are experiencing financial difficulty. You can receive forbearance if you’re not eligible for a deferment. Unlike deferment, whether your loans are subsidized or unsubsidized, interest accrues, and you’re responsible for repaying it. Your loan holder can grant forbearance in intervals of up to 12 months at a time for up to 3 years. You have to apply to your loan servicer for forbearance, and you must continue to make payments until you've been notified your forbearance has been granted."

Here is the definition of deferment from the same site:  

You can receive a deferment for certain defined periods. A deferment is a temporary suspension of loan payments for specific situations such as reenrollment in school, unemployment, or economic hardship. For a list of deferments, click here.

So, as the definitions above indicate, both forbearance and deferment are situations where a borrower is NOT making their regular payments on their loans.  Yet, for the purposes of the CDR calculation,  borrowers in forbearance and deferment are considered as borrowers in repayment.  This flies in the face of common sense and the standards used by publicly-traded companies, like Sallie Mae.  Visit Sallie Mae's 2008 10-K and you will find the calculations for chargeoffs and delinquencies to be based on "percentage of loans in repayment," which excludes forbearances and loans in school/grace/deferment.  

Second, I wanted to understand what percentage of loans in the 2007 cohort were in forbearance or deferment.  Through a FOIA request, I received data from the Department of Education that showed a count of over 1.1 million borrowers in forbearance or deferment [they were not broken out separately], representing 33% of the total "borrowers in repayment" for that cohort year.  If these numbers are to be believed, then the 6.7% cohort default rate on an adjusted basis (excluding borrowers in forbearance or deferment) would look more like 10.0%.  [This would seem to continue a trend noted in the OIG Audit of Cohort Default Rates in 2003.  That report found that in the period between 1996 and 1999, the rate of forbearances and deferments rose from 10.1% to 21.7%.] 

Expanding the scope further to look at a larger number of FFELP securitizations, Fitch Ratings calculates a deferment and forbearance index for FFELP loans which hit a historical high in 1Q 2009 (I have inquired about a second quarter update and will pass along when available).  The figures for 1Q 2009 show deferments and forbearances combined at over 28%:

• Deferments:  16.77%
• Forbearance:  11.77%

[Interestingly, Sallie Mae reported in their last 10-K, that as of 12/31/2008, their Managed FFELP portfolios had a forbearance rate of 15.2%, up from 14.2% in 2007.]

The tricky thing about deferments is the number of reasons that a borrower can receive a deferment is quite a laundry list and includes not only economic hardship but also re-enrollment in school.  There would also seem to be quite a bit of overlap with forbearances also, as it is granted in situations where borrower is "experiencing financial difficulty" while reasons for deferment include "unemployment or economic hardship."  Note that the College Cost Reduction Act made it easier to qualify for economic hardship too (from FinAid):  "The College Cost Reduction and Access Act of 2007 changed the definition of economic hardship, effective October 1, 2007. In particular, it replaced the old income threshold, 100% of the poverty line for a family of two, with 150% of the poverty line applicable to the borrower's family size."  Without detailed data it is hard to discern reasons and therefore the causes that drive a borrower into deferment.  Now, some will say that this isn't a problem since deferments are largely students going back to grad. school. Show me the data and I will gladly agree or disagree with you. 

I have kind of meandered to get here (thank you for your persistence), so what is the point?

• The cohort default rate (CDR) does not come close to capturing the challenges that borrowers are having in making payments on their federal student loans.  While the CDR for the 2007 cohort was 6.7%, a better proxy to understand the challenges borrowers face can be found in the number of borrowers in deferment (due to economic hardship or unemployment), forbearance and delinquencies (The SLA misery index for student loan borrowers).  The CDR significantly understates the magnitude of the student loan debt issue by "kicking the can" down the road through forbearance and deferment, which may make the CDR numbers look good in the short-term but avoid the more difficult question of:  Are a large percentage of students over-borrowing as demonstrated by high default rates?

• Since deferment and forbearance not only avoid defaults during the CDR calculation period, but also are counted in the denominator, there is clearly a strong incentive to place at-risk borrowers into one of these two categories.  Now I recognize that this may not be a bad thing for some borrowers...the bigger question is:  Does deferment and forbearance really help or is it merely putting off the inevitable (default that is)?  USA Funds (the largest guarantor) notes that "During a representative month, borrowers who had used no forbearance time represented nearly half (44 percent) of all defaults on USA Funds-guaranteed loans."  So, that would indicate that 56% of all defaults in a representative month come from borrowers who had some forbearance time, which I don't find particularly reassuring. 

• How do I arrive at that figure of more than 1 in 3 borrowers struggling with their federal loans?

• Using Sallie Mae's latest delinquency figures in their 2Q09 10-Q as a proxy for FFELP, 16.1% of their Managed FFELP loans in repayment were delinquent

• Based on the Fitch numbers for 1Q 2009, a forbearance rate of at least 12% (of loans in repayment and forbearances) seems likely for the 2Q09. 

• For deferments, take 50% of the Fitch deferment figure of 16.77%  (or 8.4%) assuming that about half of deferments (I think it is higher) are related to economic hardship or unemployment issues vs. re-enrollment (let me know if you have any better numbers).

My conclusions above are certainly nothing new under the sun.  In fact, in a 2003 audit report, the Office of Inspector General from the Department of Education, recognized the limitations in the CDR calculation and made the following recommendations: 

• Exclude borrowers in deferment or forbearance in the CDR calculations
• Create a subsequent cohort as the borrowers in deferment or forbearance enter repayment

The time for greater transparency of the federal loan programs is now.  Federal loans are booming (25% growth in the last year), borrowers are under greater stress due to the economy and the employment markets and the federal government (i.e. the taxpayer) is now funding almost all new federal student loan...meanwhile, the cohort default rate used to inform policymakers today so understates the magnitude of this issue to be irrelevant.  It has, however, been successful at keeping taxpayers (or Congressman for that matter) from asking too many difficult questions.  Let's hope that this situation changes for taxpayers and borrowers alike. 

Comments

[Eddie Meboy]

While I agree with much of your analysis I think what you are missing is that Cohort Default Rates are not meant to be a reflection of the challenges that borrowers are having in making payments. The purpose of cohort default rates are to measure the percentage of student that leave an institution in one federal fiscal year and default in the subsequent fiscal year (it is now being extended to defaulting in the second subsequent year). The idea being that if an institution has a high percentage of students immediately defaulting after leaving the institution then the school should be reviewed with an eye towards terminating it from the loan program.. Unfortunately, as you point out, the CDR has been used to make many inferences to the program that are not accurately reflected in the calculation.

The 2003 report pointed out many faults with the current calculation among them the fact that borrowers on deferments and forbearances are included in the universe of students “in repayment” status. However it does not mention the herculean task of accurately weeding these borrowers out. Right now repayment status is simple enough, after a borrower’s grace period has expired his status changes from “in grace” to “in repayment” those that enter “repayment status during the federal fiscal year (Oct 1 – Sept 30) are counted for that years cohort. As any school that has reviewed and challenged their cohort rate can tell you this simple tracking is fraught with errors. Trying to weed out those on a deferment or forbearance would only exacerbate the problems the feds already have trying to accurately report the data as it is now.

There can be no denying that student loan borrowers are having a hard time making their payments. Any long term analysis will show that, as will reports by the major lenders in the program, that is where the data is that deals with that issue. The CDR was never meant to reflect this problem and is therefore a poor tool to be used to do so.

[Aaron]

CDR is definitely not the whole story -- as Eddie points out above, it's pretty much limited to people who are so badly served by their schools (or so unlucky) that they default almost immediately.

A more accurate measure of overall difficulty would be percentages of borrowers currently using financial-hardship forbearances and deferments out of the entire portfolio, possibly adding delinquencies and defaults. Total percentage of loans in default is definitely another figure that guarantors watch very closely.

The problem with that measure is that portfolio composition changes from year to year. Within FFELP, for example, if a major proprietary school changes its preferred lender list and sends a lot more volume to a different guarantor, you'll see a major change in the risk profile of their portfolios over the next few years.

Even looking at student loans nationwide, it's problematic. Proprietary schools have increased their volume dramatically in the past decade, and their students default at much higher rates. How does that change the overall rate of students experiencing difficulty in repayment? It's difficult to measure, but we can safely assume it's not an improvement.