Higher Ed Watch

By Deanne Loonin

Before the credit crash in 2008, many for-profit colleges partnered with third party lenders, such as Sallie Mae, to provide private student loans to their students. When these loans started to fail at devastating rates, nearly all of these lenders exited the subprime student loan business and terminated their partnerships with these schools. 

The sudden and unexpected exodus of lenders from this market left proprietary school executives facing a dilemma. The report that we at the National Consumer Law Center’s released earlier this week, “Piling It On: The Growth of Proprietary School Loans and the Consequences for Students” highlights how many for-profit schools responded to this “funding shortfall” by creating their own student loan products. Nearly all of the large companies -- with the notable exception of the industry’s largest player, the Apollo Group, which owns the University of Phoenix -- have increased institutional lending in some way. 

Industry and Wall Street insiders often describe the growth of institutional lending at these schools as inevitable. This misses the mark because the schools deliberately chose to make the loans. They made a purposeful decision that may have benefited the companies and their investors but was not in the best interests of their students.

For-profit college executives could have viewed the pull-out of the third party creditors as a warning sign that lending without regard to repayment caused significant harm to their students. Instead, many of these school officials chose to create or expand institutional loan products. They did this even though their students were already struggling with student loan debt, both federal and private, and even though most knew that a majority of the institutional loans would never be repaid. In many cases, these loans have high interest rates and include predatory terms. 

As documented in the NCLC report, the default rates on the institutional loans are shockingly high. The only way making these loans appears to make sense for these companies is if they are recognized as loss leaders that keep the federal dollars flowing. There is so much profit reaped from federal student aid funds that the massive losses experienced from these institutional loans are simply a cost of doing business.

This surreal situation is summed up in a quote from Corinthian College executives in a February 2010 conference call with financial analysts. After describing potential default rates on institutional loans of up to 58%, Corinthian management said that they were “…feeling frankly good about what we’re offering to our students.” Really? 

The “90-10 rule,” which requires for-profit colleges to obtain at least 10 percent of their revenue from sources other than federal student aid, is critical to understanding why these for-profit higher education companies have created institutional loan programs. Among other concerns, the temporary “relief” granted to schools as part of the 2008 Higher Education Act renewal allows them to count the net present value of institutional loans in the 10% category, instead of just counting the actual payments they receive. Allowing this “relief" to lapse (as we recommend in the report) will remove a perverse incentive for schools to make these loans regardless of whether students will be able to repay them. This is one of a number of reforms to help prevent gaming of the 90-10 rule and pave the way for an honest study of its impact.

Compliance with 90-10 is essential to keep the federal dollars coming. However, the growth of institutional lending is not only about 90-10.  It is also more simply a way for schools to keep revenues of all types flowing so that profits remain high and the companies remain attractive to investors. Moreover, many schools have developed accounting systems that hide the true loss rates of the institutional loans and how these loans are impacting their companies. 

Our report includes a number of recommendations to address the problems with institutional loans and protect students, including strengthening the 90-10 rule and studying its effects. We also urge stepped up federal and state enforcement of consumer protection laws. In addition, we recommend that federal agencies, such as the new Consumer Financial Protection Bureau, focus not only on the high rates and fees, but also problems with unfair or abusive default triggers (e.g. borrowers being put into default for missing one payment), mandatory arbitration clauses (which requires students to forfeit their right to bring lawsuits against schools), and waivers of other important borrower rights. A key issue is developing an “ability to pay” standard and mandatory underwriting guidelines so that schools will face penalties for making loans that they know will fail at very high rates.

And finally, we call on Congress and the Education Department to provide relief for financially distressed borrowers, including those who have been victims of proprietary school abuses. Restoring bankruptcy rights for private student loan borrowers is a critical first step.

In the wake of the credit crisis, creating institutional loan programs was not the only option available to for-profit colleges. We know this because not all proprietary schools took this route. According to a spokesperson for the Apollo Group, the company made a deliberate decision not to go in this direction because “…quite simply, we believed it was not in the best interests of our students.” Unfortunately, most of the other large for-profit higher education companies did not follow the industry giant’s lead. Instead, they are making loans -- often high cost loans -- without regard to their students’ ability to pay and even raising tuition in some cases to ensure their own profits. For an industry that continually boasts of its commitment to serving low-income students, this is simply unconscionable.

Deanne Loonin is a staff attorney with the National Consumer Law Center and the Director of the Center's Student Loan Borrower Assistance Project. She focuses on consumer credit issues generally and more specifically on student loans, credit counseling, and credit discrimination. She is the principal author of numerous publications, including "Too Small to Help: The Plight of Financially Distressed Private Student Loan Borrowers," and "Income-Based Repayment: Making it Work for Student Loan Borrowers." Her views are her own and do not necessarily reflect those of the New America Foundation.