AFTER sky-high default rates in the 1980s, graduates are doing a better job of paying back their college student loans in the '90s.
Years of escalating rates led to a crackdown from the federal government, lenders, guarantors, and schools. Now, the rewards of that effort are showing up.
The student-loan default rate for students within two years of leaving school has fallen from 22 percent in fiscal 1990 to 12 percent in 1993, according to a survey by the National Council of Higher Education Loan Programs in Washington.
That's good news for taxpayers who have seen a savings of nearly $1 billion in three years. "A battery of reforms ... over the past few years are indeed working," says Brett Lief, president of the National Council of Higher Education Loan Programs.
Mr. Lief credits schools and lenders with improving student counseling about repayment obligations and options. "Lenders are offering a variety of repayment options to meet individual borrower needs," he says. "And guarantors are intensifying their efforts to locate, contact, and help delinquent borrowers."
At USA Group, one of the largest guarantors of federal education loans, 200 people work full-time on preventing loan defaults. "Typically, if we can find you, we can help you get back on track," says Susan Conner, vice president for public affairs at the company. "Once we hear that a loan is heading into default, we work to avert it. The ones we can't avoid, we work with once they are in default. We are eventually successful in getting more than half the loans that default to repay."
At the same time, federal regulations have gotten stricter in recent years. Federally guaranteed student loans are the primary source of financial aid for American college students.
Since it was created in 1965, this program, now known as the Federal Family Education Loan Program (FFELP), has funded more than 75 million student loans worth over $185 billion. Private lenders provide the capital for the loans, and private and state guarantor agencies process them. The federal government subsidizes the interest rate, guarantees the loans in case of default, and exercises regulatory authority over the program.
In 1993, a new regulation disqualified schools with default rates above 25 percent from the program. "A number of schools have been forced out of the program because their default rates were too high," says Patricia Scherschel of USA Group. Trade schools, which have a reputation for high default rates, are finding themselves out in the cold in some cases.
Schools now have an incentive to do a better job of counseling student borrowers about repayment options. New regulations hold the educational institutions partially responsible if too many of their students default on loans.
"Some defaults were a function of the fact that people thought they could get away with it," Ms. Scherschel says. "You could discharge the debt more readily through bankruptcy. Now you have to be in repayment for at least seven years before you can discharge a student loan through bankruptcy. That means you can't just walk away as soon as you get out of school."
Surprisingly, many people don't even realize they have defaulted on a student loan. "One of the leading causes for default is the failure to process paperwork for a deferment when going back to school," Ms. Conner says.
"And it's not the people who are up to their eyelashes in debt who default," according to Conner. "In fact, it tends to be people with fairly small loan amounts." The average defaulted loan totals $3,500.
"Most of these students have gone to trade schools that have fairly short programs," Conner says. "They don't manage to run up huge bills. But in the scheme of things, they are huge for them because if they don't have a job when they come out, it's going to be tough to pay $3,500 back."
But lenders and guarantors have gained some new mechanisms for getting loans repaid. The Internal Revenue Service will now withhold tax revenues of defaulted borrowers and apply those funds to the outstanding loan. Some states will also withhold state tax refunds or even lottery earnings.
Administrators of student loans are also being forced to bear their share of the risk. The Student Loan Reform Act of 1993 lowered the reinsurance rate paid by the federal government for defaulted student loans. "We now must assume responsibility for 2 to 22 percent of every defaulted loan," Conner says. The scale is set according to the agencies' performance in preventing defaults.
The reinsurance rate may be lowered again soon. Pending legislation that is part of the budget reconciliation act would further reduce the reimbursement rate for banks to 95 percent and coverage for private guarantors would drop from 98 to 96 percent.
"The effect of that is that for every $1,000 in defaulted loans, the federal taxpayer would only pay $90 to $120, and the rest would have to be eaten by the industry - by the lender and the guarantor," Scherschel says.
Everyone wins with decreasing default rates. The trick is to keep the downward momentum going. "But there are lots of wildcards in determining what the future of default rates may be," Conner says.
The Clinton administration is touting its direct-lending program as a way to keep defaults down. But critics say it could actually lead to higher default rates.
Under the direct-lending plan, which began on a limited basis in 1994, students borrow directly from the federal government through their schools. The plan is administered by the US Department of Education, which critics say has a poor record of managing defaults.
"Direct lending does not even have an approved model for how to track defaults," Conner says. And schools with high default rates that make them ineligible for the FFELP program are moving to the new direct-lending program with immunity, other critics argue.
"It's like giving them a get-out-of-jail-free card," says Rep. Bart Gordon, a Tennessee Democrat and sponsor of a bill that would cap the direct-loan program before 1997-98, when the Clinton administration would like it to reach 100 percent participation.
"If direct lending gets capped and we're under the constraints of the FFELP as we know them now, the future is probably more predictable," Conner says. "We know the rules and how they have successfully averted default in the last three years."