A new analysis of student loan borrowers shows that, contrary to public perception, those who borrow the least are most likely to default on their loans.
The study, which examined borrowing by community college students in Iowa, found that 31% of those with loan balances of less than $5,000 defaulted, compared with 22% of those who owed between $10,000 and $15,000. The national average default rate across all educational institutions is less than 14%.
The study adds credence to a changing understanding of the $1 trillion student debt crisis, suggesting that the riskiest borrowers are not those who have taken out tens of thousands of dollars in loans to cover high tuition costs, but those who borrow in small amounts.
So far there has been little effort by the federal government to help such borrowers, according to the study, released Monday by the Association of Community College Trustees. But that could change: the Obama administration has recently made free community college a key part of its education agenda, proposing a national program and pushing states to adopt their own initiatives.
Though a relatively small percentage of community college students, around 17%, take out federal loans — and borrow much less than those who attend pricier colleges — those that do borrow are more likely to default than students at both public schools and for-profit colleges. The national three-year default rate for community college students is 21%, compared to 19% at for-profit colleges.
And while the figures involved are lower, failing to repay loans can still throw borrowers into a cycle of financial troubles, with few options to emerge from default and no way to discharge loans in bankruptcy.
"The repercussions of default are the same whether you default on a $35,000 loan or a $3,000 one," said Colleen Campbell, one of the report's authors. "The hit on your credit stays for seven years," Campbell said, which can be devastating for low-income borrowers.
Community colleges, open-access institutions which typically accept all students, have traditionally had sky-high dropout rates, which the analysis indicated were likely tied to loan defaults. The vast majority of Iowa students who defaulted on their loans, almost 90%, never earned a credential of any kind, and 60% earned fewer than 15 credits, the report found. Twenty-six percent of students who defaulted didn't earn a single credit.
And few community college students made use of any of the federal programs meant to help people avoid default, like deferral, forbearance, or income-based repayment. That is in part because federal programs themselves fall short when it comes to low-income borrowers at community colleges with low loan balances, said Campbell.
Enrolling in an income-based repayment plan, for example, is a complex process, requiring submitting tax documents as proof of income every year, although Campbell said a significant portion of low-debt borrowers earn too little income to have to file taxes. And in the standard repayment plan, the minimum monthly payment set by the government — $50 — is often too steep for many to afford, and makes little sense for a loan with a balance of less than $5,000.
"If I borrowed $1,000, none of the programs work for me," said Jee Hang Lee, the vice president of public policy at the Association of Community College Trustees, a trade group.
The analysis found that two-thirds of students who defaulted had never made a single payment on their loan, with the majority defaulting within the first year — an indication that they were likely misinformed about how to repay their loans or whether they owed any money at all, said Campbell.
"There's something that’s not sticking with them about the borrowing process," she said. "There may not be enough done on the front end" to ensure that borrowers know they are taking out loans they are obligated to repay whether or not they earn credits or credentials.
The analysis also pointed to potential problems with student loan servicers, who the government relies on to communicate with borrowers, and collections agencies, which it charges with helping students who have gone into default. The Education Department has previously found fault with collections for failing to accurately inform borrowers, especially about plans like income-based repayment; it fired five of them in February for providing "inaccurate information."