Thursday, September 03, 2009

PLUS again

by Andrew Gillen

Ben Miller responded to my post on PLUS loans yesterday and brings up a number of points which I’d like to address.
  • the U.S. Department of Education sent a letter to 921 schools in the Federal Family Education Loan (FFEL) Program that had more than 80 percent of their volume with a single lender.
This certainly gets at the prevalence of monopoly, and I was surprised that so many schools were dominated by a single lender. But I imagine (I couldn’t find a list) that these 921 are relatively small, so the proportion of students might be much smaller than that number would imply. However, if we assume that they are a representative/random sample, that is about a quarter of title IV institutions, which when added to the 1 in 5 denial rate from DL would give us the 2 in 5 denial for FFEL.

My main issue is that this letter went out to these 921 schools in 2007, so wouldn't this issue have surfaced back then? If there wasn't much difference in DL and FFEL denial rates back then, I'd be inclined to mark up current disparities to craziness in the financial markets. Either way, the solution to this problem is get rid of the monopolies at those schools.
  • the denied PLUS applicants may be less likely to shop around, perhaps based upon the assumption that if that lender turned them down so will everyone else. In that case, if a lender denies a PLUS loan but then offers a private option right away, it may be very attractive to the parent.
This is a really good point that's got the potential to explain much of what’s going on. He later notes “these same lenders making the denial decisions also have the ability to market a competing and more expensive product makes me concerned that there are too many opportunities for a conflict of interest.” I would think that one of the tasks of the financial aid office would be to steer students toward their best option, reducing the potential threat of this. But we’ve seen corrupt financial aid offices before, and the fact that 921 apparently allow(ed?) near monopolies doesn’t instill confidence. It seems to me that if they aren’t already doing so, institutions should ensure that their financial aid offices have a) strict bans on bundling rejection of PLUS with offers of private loans, and b) a lending tree approach to loans – one application, with the borrower then seeing which lenders accept and at what terms.
  • First, if lenders feel like the risk of a PLUS loan isn’t worth it, shouldn’t they have similar feelings about Stafford loans?
There are two keys to understanding why lenders may approve students for Stafford loans, but not for PLUS. First, since the interest rates are lower, students will max out Stafford, and parents will prefer home equity loans before moving on to PLUS. Second, Stafford loans are capped at relatively reasonable levels as far as repayment is concerned. Currently, the limit on Stafford loans is $23,000 ($31,000 if all unsubsidized). As Liz Pulliam Weston notes, “A good rule of thumb is not to borrow more, in total, for an education than you expect to make in salary your first year out of school.”

Thus, pretty much any graduating student with a decent job will be able to make the payments on their Stafford loans, even if they take out the max. Lenders will therefore be willing to lend. The story is different for PLUS loans, since lenders know that the borrower has probably already maxed out on Stafford loans (meaning the student is unlikely to be able to help repay), and that the parents couldn’t get a better deal on a home equity loan (meaning they probably already have debt issues), both of which make default, and therefore PLUS denials, more likely.
  • But the issue is not with the rate of PLUS loan denials, it’s the difference in that rate between the two programs. I can’t believe that the borrower populations in the two programs is so different that the denial rate in FFEL would be double what it is in the Direct Loan Program. And that’s what caused the red flags to go up.
This is the main disagreement. We’re both assuming that the populations of applicants are the same. He sees the higher denial rate for FFEL as a potential red flag about the private side – FFEL lenders are trying to increase profits by pushing people into private loans with higher interest rates. I think that competition rules that possibility out, so I see the high denial rate of FFEL as a potential red flag about the public side – DL may be accepting too many people with unlikely prospects of repayment. We all know that financial companies are like a "great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money," so if the squid is staying away, maybe there is a good reason.

Which of these stories is right hinges on how monopolistic student lending is. I’m still not sure that enough big schools have 1) a monopoly and/or 2) unethical financial aid officers to produce the reported aggregate figures. But I could be convinced otherwise.


Ben Miller said...

Hi Andrew,
I think you make some very good points here, especially about the Stafford versus PLUS distinction, which is something that I hadn't considered.

To answer your question about why this might not have been considered earlier, the data used by Mark Kantrowitz comes from the National Postsecondary Student Aid Study, which is only run every few years. The data in it actually come from 2007-08.

I do think you make an interesting point about how lenders generally might want to stay away from PLUS and that the Direct Loan Program is too accepting, but it also seems surprising given the two time frames considered. In both 2003-04 and 2007-08 credit was still pretty plentiful and the student loan business was booming. I think it was 2005 or so that Sallie Mae was well in the top of the Fortune 500.

Also keep in mind that in 2003-04 the subsidy rate on PLUS loans was higher than it was in 2007-08. If the profitability of loans was a concern, wouldn't the decreased subsidy rate have increased the rate at which borrowers get rejected? It's possible they did reject more and it's just that more borrowers applied so both the numerator and denominator grew. But given the fast and loose credit policies of the time, especially with respect to home loans, I would have guessed that additional PLUS borrowers at this point in time would be much worse from a credit profile standpoint.

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