Student-Loan Defaults Rise with Unemployment

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BOSTON (TheStreet) The weak economy and double-digit unemployment rates have caused student-loan defaults to hit their highest level in nine years. It's a trend that could cost the government billions of dollars and harm the creditworthiness of an up-and-coming generation.

Federal student loan borrowers are considered in default if they don't pay for 270 days. The default rate increased to 6.7% for fiscal 2007 from 5.2% in fiscal 2006, according to the most recent figures available from the Department of Education.

The rate represents borrowers whose first loan repayments came due between Oct. 1, 2006, and Sept. 30, 2007, and who defaulted before Sept. 30, 2008. Nearly 3.3 million borrowers entered repayment during that time, and more than 225,300 borrowers divided among 5,776 institutions defaulted.

Because federal default statistics are typically two years old by the time they are processed and released, the most current data is starting to reflect the recession's impact. That suggests that defaults could rise further.

In 1990, nearly one in four borrowers defaulted on their federal loans when default rates set an all-time high of 22.4%. The rate dropped to a record low of 4.5% in 2003.

"When a borrower falls 60 days or more behind in paying back a federal student loan, they are required to contact a guarantor and seek assistance," says Bob Murray, a spokesman for USA Funds, an Indianapolis-based loan guarantor. "Requests from lenders is up 20% year-to-year, so it's pretty clear that the economy is having a significant impact on the repayment success rates of students. We have a financial stake if a borrower defaults. We are on the hook financially for part of it."

USA Fund's employees have made 85 million phone calls to borrowers who were behind on payments. The group says these efforts and counseling helped avert defaults on more than 93% of the accounts it handles, preventing defaults on more than 1.5 million accounts that might have cost taxpayers $22.5 billion or more.

Kimberly Carter, repayment assistance manager for Boston-based American Student Assistance (AMSA), is used to hearing "get in line" when she reaches out to past-due graduates.

"There are options with federal student loans that are different from consumer debt or other types of debt," she says. "If we can just get them on the phone and talk to them, we can usually provide some assistance to them. You don't want to sound threatening or scare them, but they have to understand that their student loan is not going to go away, even if they file bankruptcy."

AMSA, a federally funded nonprofit, became the nation's first private student loan guarantor in 1956. It manages more than $45 billion in loans.

"In the past, our business model was about collecting on defaulted loans," Carter says. "About 10 years ago, we decided that we should focus on helping people keep their loans in good standing and preventing defaults and delinquencies before they occur."

That challenge will likely grow as students rely on more loans to finance their educations. According to the U.S. Education Department, federal student-loan disbursements for the 2008-09 academic year totaled $75.1 billion, a 25% increase over the previous year. The single largest beneficiary of these loans was Apollo Group (Stock Quote: APOL), a for-profit education company that owns the University of Phoenix. Federal loans constituted more than 86% of its $3 billion in tuition revenue.

Six months after graduation, when the first bill arrives, is often where problems first emerge. May's graduating class will start receiving bills this month.

There are several options for borrowers falling behind, including repayment plans with monthly sums that start low and increase along with the debtor's salary. A new option enacted by Congress on July 1 allows qualified borrowers to limit their monthly payments to 15% of their discretionary income. Payments can also be deferred up to three years if the borrower can prove a hardship, such as unemployment.

Congress is working on a package of financial aid reforms. A bill passed by the House in September that's awaiting approval from the Senate would remove private lenders from their middleman role in the distribution of federal loans. Proponents of the legislation say it could save the government $80 billion to $87 billion during the next 10 years, which could help increase the loan pool. The move could have a dire impact on lenders, such as SLM (Stock Quote: SLM), better known as Sallie Mae, which manages more than $192 billion in federal and private loans for more than 10 million borrowers.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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