Student Loan Defaults in Texas: Yesterday, Today, and Tomorrow

Executive Summary

The Texas student aid community will gather in Austin on June 8 to discuss the current state of student loan defaults. The meeting follows ten years after a similar conference first addressed the issue. This paper (1) provides a review of the recommendations made at the 1988 Strategic Default Initiative (SDI) conference, (2) traces significant trends in student loan defaults in Texas, (3) describes an econometric model for predicting default behavior, and (4) explores the public policy implications of the findings. The student default situation has substantially changed since 1988. Default rates have declined and the typical defaulter no longer attends short-term vocational programs. Increasingly, defaulted borrowers have attended four-year schools and have carried larger debt loads than defaulted borrowers did ten years ago.

Defaults are implicit within a system of publicly guaranteed loans. However, the sharp rise in student loan defaults in 1988 threatened the financial stability of the entire student loan program. Conferees offered two hundred and three recommendations to prevent defaults. Texas student loan partners — schools, lenders, secondary markets, student loan servicers and guarantee agencies — adopted many of these proposals as standard business practices. Still other recommendations were written into law by state and federal governments. The policies can be grouped into three major categories: (1) improve communication both with borrowers and among student loan partners, (2) limit borrowing for students most at risk of defaulting, and (3) provide proper incentives for repayment and disincentives for default.

Default rates declined rapidly in response to the implementation of many of the Texas recommendations. Reaching a peak of 33.6 percent in FY 1990, default rates decreased to 14.0 percent just five years later. Lower default rates occurred in all school sectors, but especially among proprietary schools where rates dropped from 48.3 percent in FY 1990 to 23.8 percent in FY 1995. In FY 1990, 70 percent of all default claims paid by TG were for borrowers who last attended a proprietary school. Students from proprietary schools now account for only 26 percent of TG default claims. Meanwhile, in 1990, 20 percent of TG default claims were for four-year college borrowers. By 1997, this percentage had risen to 58 percent. The intervening years saw tremendous growth in borrowing, particularly among those attending four-year schools. While default rates have declined overall, annual default amounts have remained relatively stable.

The need to better understand the characteristics of today’s defaulted borrowers prompted the development of an econometric model that can predict, with reasonable accuracy, which borrowers will and will not default. Among the key factors associated with default are:

  • Failure to progress academically: Borrowers who are unable to complete their programs of study seldom find jobs related to their training or which allow them to earn enough to repay their loans.
  • Proprietary school attendance: Holding other characteristics constant, proprietary school attendance appears to have a negative effect on a borrowers’ ability to repay their loans. While the acquisition of additional data may weaken the independence of this effect in the model, it appears as though four- and two-year colleges that offer broader, less specialized, and longer-term education better enable borrowers to repay their loans than those who attend short-term for-profit vocational schools.
  • Selecting a school with a previous higher default rate: Choosing a school wisely entails a review of the institution’s previous cohort default rates. Previous rates are strong indicators of future default experience.

In-depth interviews were conducted to supplement the quantitative model. These interviews highlighted several important dimensions of the issue of defaults:

  • Finding and holding a job are extremely important factors affecting one’s ability to repay his or her loans.
  • A deep personal commitment to repaying one’s loan was very noticeable even among borrowers who have had traumatic life experiences that might have driven other people into default.
  • While many borrowers were able to withstand a traumatic life experience (e.g. job loss, large medical expenses, a new dependent, divorce, incarceration, etc.), multiple traumatic experiences often helped send borrowers into default.
  • Repayers tended to have a much better understanding of their loan options than defaulters.

From the findings of this report, five major policy implications were discerned:

  1. Defaults are not confined to one school sector.
    Where once defaults seemed primarily a problem that occurred at proprietary schools, other more traditional school sectors now account for the majority of defaults. The public policy response to today’s default situation should address the minority of students at good schools who — as a result of various life traumas — get into trouble with their loans. One way to help borrowers through life’s rough spots might be to better inform borrowers of the availability of deferments and forebearances.
  2. The need for wise education investments.
    While investing in a college education typically pays off quite well, there remains an element of risk in each investment. Prospective students should consider a school’s retention, graduation, and default rates when selecting a college. Better consumer information will let prospective students make wiser investment decisions.
  3. Limit borrowing for students most at-risk of defaulting.
    Both the econometric model and the anecdotal evidence from the in-depth interviews seem to confirm the connection between dropping out and defaulting. Measures which limit borrowing for early dropouts — such as late and multiple disbursements and low loan limits for first-year borrowers — appear to be sound, provided that schools actually have a problem with early dropouts.
  4. Promote academic success.
    Borrowers who progress to higher grade levels and complete their programs of study become more economically productive and less likely to default. Policies and services that promote college retention and persistence will have the added benefit of lowering defaults.
  5. Help students find and keep jobs.
    The transition from school to work can be hazardous. Efforts to smooth this transition will go a long way towards empowering borrowers and making them better able to repay their loans. Employment while in school may be beneficial, especially if the work is related to the student’s instruction and if the number of hours is low enough to allow for adequate study.

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