NEW YORK (MainStreet) The Obama Administration is showing why it is difficult to maintain credit standards for government loan programs.
Secretary of Education Arne Duncan sent a letter, dated August 13, 2013, to Congresswoman Marcia L. Fudge (D-OH), the chair of the Congressional Black Caucus (CBC), about the Parent PLUS Loan program. Duncan assured her that the Department of Education (ED) is collaborating with Historically Black Colleges and Universities (HBCUs) about reconsidering Parent PLUS loan applications that were denied after the ED implemented stricter underwriting criteria.
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He implied that the ED is going to make the PLUS Loans easier to appeal. Parents who were given a PLUS loan in the past and were denied, once the new underwriting standards were installed, may find that the appeal process friendlier. The same goes for first time borrowers who were denied.
Duncan wrote: "We have used our authority to consider 'extenuating circumstances' as a method to provide immediate relief for many students, which allowed previous PLUS loan recipients and applicants whose adverse credit determinations were based on a 'de minimis' amount of debt to obtain a loan through the reconsideration process. We engaged in extensive outreach to institutions, families, and students to make them aware of this opportunity, and we know that these efforts helped many students and families ultimately obtain a PLUS loan. The Department also provided assistance and training for financial aid officers, families, and guidance counselors in a number of communities, including some specifically requested by the CBC. The Federal Student Aid ofñce (FSA) has intensified its efforts by communicating with each HBCU President and Title IV staff, providing them with customized support as they assess their needs related to PLUS loans originatìons and disbursements, and to ensure that they are aware of the FSA tools that are available to assist them. We also provide weekly reports to all Presidents so that they can monitor the reconsideration results."
Duncan's letter was in response to pressure from the HBCU's that they are bearing the brunt of the credit tightening standards for Parent PLUS loans. Denial rates because of adverse credit established by the stricter underwriting left the HBCU's with fewer enrollments.
The PLUS loan certification became tighter in 2011. African American parents, who frequently use Parent PLUS as a means of getting their kids a slice of the American dream, were being denied in greater percentages because they ran afoul of the tighter adverse credit criteria.
Initially the regulations rejected borrowers who had accounts that were more than 90 days delinquent or who had any foreclosures, bankruptcies, tax liens, wage garnishments or defaults within the past five years. This changed in October 2011 to also consider any unpaid accounts in collections, or unpaid charged off balances, from the past five years.
HBCUs apparently were not notified of the new criteria and, faced with dwindling enrollment, were threatening to sue the Obama administration. African-American parents were understandably disconsolate as were the students.
The stricter underwriting guidelines were instituted after a study showed that private lenders had denied Parent PLUS loans at twice the rate of the government loans. The objective was to lessen default rates and save taxpayers money.
The politics involved makes almost impossible to maintain standards. It is déjà vu all over again. Many politicians claimed the politics of government backed mortgages, specifically the Community Reinvestment Act as well as Fannie Mae and Freddie Mac, relaxed underwriting standards for mortgages. This caused the housing bubble to burst nearly taking the economy with it.
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Will this be the case with government backed student loans? Many think it will.
"Applicants with total delinquent debt less than the de minimis amount and no new issues on their credit report who seek reconsideration will be approved for a loan," Duncan wrote to Rep. Fudge. "We believe this may help families who have relatively small adverse credit events that negatively impact their credit histories, such as unpaid medical debt, parking tickets, or cell phone bills of greater than 90 days duration."
These comments by Duncan would lead one to believe this shows that the government cannot objectively underwrite loans. But others are not too sure.
Mark Kantrowitz, an expert on financial aid, said that the ED's new underwriting criteria did nothing to affect defaults.
"Parent PLUS default rates are among the lowest of any government education loan programs," Kantrowitz explained. "They are denying the loans to people who were probably still going to repay the loans."
He then offered some common sense solutions to guarding the taxpayers' money. He said there are more effective ways to prevent Parent PLUS loan defaults.
"If they (ED) wanted to improve the default rate they should have added in some sort of Debt-to-Income ratio," he said. "If you look at the distribution of the Parent PLUS loans the bottom tenth percentile of obtaining loans has a debt-to-income ratio of 38%. This is unsustainable."
"Loan limits should also be based on ability to repay not the amount of the tuition," Kantrowitz added.
MainStreet has already addressed the lack of underwriting standards for student loans in a two part series called Loans Organized Crime Might Envy. Those reports noted that the Consumer Financial Protection Bureau (CFPB) was concerned about the ease with which loans were made.
The CFPB said, "....lenders were more likely to originate loans to borrowers with lower credit scores than they had previously been. These trends made private student loans riskier for consumers... Accordingly, to the extent lenders underwrite on the basis of the student's application rather than the creditworthiness of a co-borrower,lenders must choose some basis to distinguish borrowers who are more or less likely to repay out of a group of borrowers who have little to no credit history and whose future earnings are uncertain."
Since Parent PLUS loans like other student loans are near impossible to discharge in a bankruptcy, applicants might not necessarily benefit from more lenient underwriting. While looser underwriting benefits colleges and universities, whether they are HBCU's or not, the borrowers will be the ones who will have to pay the bill whether they can afford to or not.
--Written by Michael P. Tremoglie for MainStreet