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Condemning Students to Debt Is the College Loan Program Out of Control?
	By Richard Fossey   Everyone in the higher education community should be worried about developments in the college loan program, Mr. Fossey warns. The day may be coming when not just trade school students but large numbers of college graduates will be unable to meet their loan obligations. Illustration © 1998 by Jim Hummel

IN OCTOBER 1998, Richard Riley, U.S. secretary of education, announced some very good news. According to the secretary, the default rate on federally insured student loans had declined for the sixth straight year. In fiscal year 1990 the default rate peaked at an astonishing 22%. More than one in five student debtors defaulted on their loans in the year they came due or within a year thereafter. Since then, the rate has steadily declined. By fiscal year 1996, the last year that has been calculated, the default rate had been cut by more than half, to just 9.6%.

This is an extraordinary accomplishment. Congress and the public have been worried about high default rates for many years, and the recent data seem to indicate that the federal student loan program is operating efficiently and is under control. Unfortunately, it may be too early to pop the champagne corks and begin celebrating. In spite of declining default rates, evidence is emerging that the student loan program has deep underlying problems.

Accelerating Growth and a Growing Burden for Students

First, the declining default rate must be viewed in the context of a federal program that has exploded in recent years. In fiscal year 1990, when the default rate reached 22%, the student loan program guaranteed about $13 billion in student loans. Since then, the default rate has declined by more than half, but the amount of student borrowing has almost tripled. In fiscal year 1998, postsecondary students borrowed $38 billion. Even if the Department of Education succeeds in keeping each year's default rate in the 10% range, the dollar amount going into default each year will still be quite large, probably as large as when the default rate was at a record high.

Second, there are worrisome signs that student borrowers are finding their loans more burdensome than in the past. If so, the default rate could well start back up again, as debtors find themselves squeezed tighter and tighter by their student debts.

A major reason for worry is the kind of student loans that many students are now receiving. Until 1992, most federally guaranteed student loans were subsidized: the government paid accruing interest costs during the time that borrowers were in school. Today, about one-third of student loans are unsubsidized. For these unsubsidized loans, interest costs begin accruing as soon as loan funds are disbursed. These costs are simply added to the principal of the loans that students must repay. For example, a freshman who borrows $2,500 a year for college expenses and matriculates in four years has a loan obligation of more than $12,000 -- the $10,000 she actually received, plus four years' accumulated interest. Obviously, a student who takes out an unsubsidized loan has a significantly higher monthly loan payment during the repayment years than a student who receives the same dollar amount from a subsidized loan.

Another sign that loans are becoming more burdensome is the amount of debt that students now take on. According to the General Accounting Office (GAO), students are borrowing substantially more today than their counterparts did just a few years ago. In 1995-96, graduates of four-year colleges had borrowed an average of about $13,000 during the course of their studies. This is about 30% more than the amount borrowed by a typical college graduate in 1992-93, when the average amount borrowed was $10,000 (in constant dollars).

As David Campaigne and Don Hossler have pointed out, the average student's cumulative indebtedness has been growing for years. Between 1985 and 1991, it grew by 153%, from $6,488 to $16,417. Unfortunately, growth in borrowers' incomes has not kept pace with their growing debt burden. According to Campaigne and Hossler, cumulative debt rose from 6.23% to 9.52% of gross income between 1985 and 1991.

To lighten this growing debt burden, Congress has developed some alternative repayment options. Students can now elect to pay back their college loans over a longer period -- up to 25 years. These options might contribute to the declining default rate, since extending the payment period lowers a borrower's monthly payments. Of course, extending the repayment period substantially increases the total cost of a student loan, because the loan accrues interest over a longer period of time. At current interest rates, a student who borrows $80,000 and pays the loan over a 25-year period will accrue more than $100,000 in interest costs.

Obviously, extending the repayment period is an imperfect solution to the growing burden of college loan debt. Indeed, it is chilling to contemplate the prospect of thousands of former students taking a quarter of a century to pay off their college loans. Even the youngest borrowers who elect this repayment option will be saddled with educational debt well into middle age. Older students who opt for a 25-year repayment schedule could be paying on their student loans after they retire.

Storm Warnings from the GAO

Finally, there is a third reason to worry about the student loan program. According to the GAO, there are serious problems with the program's management and design. In a 1997 report, the GAO described fundamental flaws in the student loan program and concluded that "the financial interests of the U.S. taxpayers are not well served."

For several years, the GAO has referred to the student loan program as a "high-risk" area. Again and again, the GAO has called attention to fraud and abuses in the program, particularly in the proprietary school sector. The GAO has also turned up evidence of mismanagement: loans have been given to ineligible students, and students have been given additional loans even though they had defaulted on earlier obligations.

Perhaps the most alarming problem that the GAO identified is the lack of accurate data about how the student loan program is operating. The GAO has repeatedly pointed to this problem. In a 1996 report, the GAO concluded that "unreliable loan data" prevented the U.S. Department of Education from reasonably estimating program costs. In particular, the GAO determined that the department did not have procedures in place to ensure that billing reports from guaranty agencies and lenders were reliable.

In a February 1997 report, the GAO said again that student loan data were unreliable. "As a result," the report concluded, "the Department cannot obtain complete, accurate, and reliable FFELP [Federal Family Education Loan Program] data necessary to report on its financial position." In other words, because of faulty information, the U.S. Department of Education may not have an accurate picture of its student loan liabilities.

In addition to calling for better data control, the GAO identified two fundamental flaws in the student loan program, flaws that still remain. First, as the program is now structured, the federal government bears nearly all the risk of loan losses, a fact that gives lenders little incentive to keep defaults to a minimum. Second, the program lends to students who run a high risk of default: low-income students and students who attend proprietary schools or other nontraditional postsecondary institutions. According to the GAO, these two flaws have increased the student loan program's costs and contributed to high default rates.

One cannot read the GAO reports on the student loan program without a sense of foreboding. Taken together, these reports constitute a series of warnings about a massive government program's problems. With each passing year, the program grows larger, and it becomes increasingly dangerous to ignore these warnings.

In fairness, Congress and the Department of Education have taken steps to make the student loan program more efficient and to reduce fraud and abuse. The declining default rate is evidence of that. Nevertheless, the fundamental problems that the GAO identified -- inadequate information from lenders, mismanagement, and insufficient safeguards against imprudent lending -- have not been fully remedied.

Higher Education's Lack of Concern

For the most part, college and university leaders are unconcerned about the explosive growth of the college loan program. That is not surprising. Colleges and universities have benefited enormously from that growth; student loans are a major reason that in recent years institutions have been able to raise tuition at a rate that outpaces inflation. Although students are becoming increasingly burdened by their college loans, most still pay them back.

But the past may be no indication of the future. Student loan volume is growing. At the present annual rate, students will borrow about a quarter of a trillion dollars in the next seven years. We may reach some "tipping point" when the dynamics of the program change fundamentally for students, institutions, and the national economy.

The Need for Better Information

Surely it is time if not for worry at least for greater vigilance. At a minimum we need to do three things to make sure that the benefits of the student loan program are not overwhelmed by negative consequences.

First, we need to get better information about how the student loan program operates, and we need to do this quickly. As the GAO has repeatedly warned, the Department of Education has inadequate loan data. What is needed, according to the GAO, is an integrated information technology or "systems architecture" for managing the Education Department's financial aid programs. The department is making progress in this area, but the work is not yet done.

Second, we need to pay close attention to some key indicators of loan repayment behavior. Historically, students who attend four-year institutions have had the lowest default rate. If the default rate for this category of students -- those students least likely to default -- goes up significantly, that will be a warning that individual debt loads are becoming dangerously burdensome.

We also need to watch the repayment patterns of borrowers who build good repayment records in the first few years after their loans are due. Most borrowers who default do so almost immediately, within a year or two after their payment obligations have begun. If a significant number of borrowers begin defaulting on loans after three or four years of regular payments, that too will be a signal that loan obligations are becoming more burdensome for individual borrowers.

Third, we need to know more about the effect that college loans have on borrowers during the repayment stage. We know that many individuals pass up satisfying careers in order to take better-paying jobs that will enable them to meet their loan obligations. However, we have no idea how many people have been affected in this way.

We know that defaulters can be banned from further participation in the loan program and that thousands of would-be borrowers are denied new educational loans every year because of their poor repayment record. We have no notion of how many people in this predicament are individuals who took out student loans to pay for worthless trade school programs and were then unable to pay their debt.

In closing, I think it's appropriate to recall a 1987 article by Wellford Wilms, Richard Moore, and Roger Bolus, in which they analyzed default rates on student loans as they were going up during the mid-1980s. Just as "a chronic cough often foreshadows a serious illness," the authors wrote, "escalating default rates testify to an underlying malady in the [student loan] program itself."

Eleven years later, we have seen loan default rates cut in half, but the "chronic cough" has not gone away. Other signs, just as portentous, indicate that the nation's mammoth college loan program still has serious ills. Student loan volume is mushrooming, individuals are assuming heavier debt loads, and the program continues to lack sound management.

Everyone in the higher education community should be worried about these developments. So far, it has mostly been trade school students who have been seriously injured by student loans. Thousands of trade school students borrowed money that exceeded the value of their training. When they subsequently defaulted on their loans, they were precluded from further participation in the student loan program.

The day may be coming when not just trade school students but large numbers of college graduates will be unable to meet their loan obligations. At present, few college students borrow so much money that their indebtedness exceeds the economic value of their education. But annual loan volume almost tripled in just seven years, and the average student's debt burden is continuing to rise. If we continue on our present course, student loan obligations will some day make the benefits of higher education seem far less clear than most of us can now imagine.

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Last updated 6 January 1999
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