Capella Policy Paper on Student Debt

July 25, 2012

Below is a policy paper on student debt that Capella Education Company has drafted and is sending to policy makers, higher education thought leaders and media. It is the second in a series. Please share it and let me know what you think.

To Interested Policy Makers, Higher Education Thought Leaders, and Media:

Higher education is a national imperative to advance our competitiveness and individual opportunity. The federal government recognizes this reality by making large and essential investments in spending on student aid. Unfortunately, this investment is not producing sufficient results. As a country, the United States sees too few students graduating, increasing student debt and a widening skills gap. While the national investment in providing student aid is exceedingly important, it is necessary to be sure the expenditures return value and are used as effectively as possible. In this, students, institutions and the federal government all share responsibility.

As legislators, the Department of Education and thought leaders struggle to address these challenges in an environment of declining federal resources, it is critical that policy be shaped by clear priorities, data and measures of accountability. Last month, Capella Education Company produced the first in a series of white papers outlining our views about the future of higher education policy. In that paper, we talked about a population of working adult Americans who are at the heart of American competitiveness but are underserved by the current system of higher education; made a case for removing policy barriers to innovation; talked about a constructive role for the private sector to play in higher education; and laid out three specific policy proposals to increase data and accountability in higher education.

In this second white paper, we will take a look at an issue very much in the public eye today: student debt. Much attention has been placed in recent months on the issues of student loan interest rates and on Pell Grant funding. These are unquestionably important issues, but they only scratch the surface of the trillion dollar student funding issue.

It is important to be clear that there are many aspects of our federal student loan system today that work. Most significantly, it goes a long way to accomplishing the important policy objective of providing access to higher education for thousands who would not otherwise be able to afford it. However, the current system also allows individuals to borrow more than is required to pay the cost of tuition, allows limited flexibility on repayment, and can be highly complicated. These are serious issues. They can and must be fixed.

In this paper, we seek to:
o Use publicly available data about Capella and other institutions to demonstrate the impact that borrowing above the cost of tuition, books and fees has on student debt;
o Offer a series of near-term policy solutions to address the issue of over-borrowing;
o Put forward solutions for a repayment system that helps those struggling with student debt repayment while protecting taxpayers; and
o Identify ways for higher education institutions and the Department of Education to work together in educating and advising students on responsible borrowing.
For a brief summary of our recommendations, please see the attached policy summary.

Filling in the cracks in today’s federal student loan system will not fix all of the problems of higher education. However, in conjunction with increased outcomes measurement and institutional accountability, we believe rational changes to our federal student loan system can advance two critical policy objectives:
1. More directly connect cost to value in higher education; and
2. Create an environment in which policy makers can make more effective financial aid investments and sustain federal funding at a reasonable level at a time when federal resources are increasingly limited.

A Proposal for Rational Changes to Federal Student Loan Policy

It is difficult today to avoid the themes of higher education financing and student loan debt; on any given day you can find dozens of articles on these and related topics. By now, we have memorized the facts: the average college graduate has $27,000 in student loan debt; higher education debt levels have exceeded credit card debt for the first time in our nation’s history, and student loan debt has exceeded $1 trillion. We know the facts and the figures and that Occupy Wall Street protestors are calling for student loan forgiveness en masse. While college tuition costs and conversations around affordability are important – so much so that we will address in a subsequent white paper — there is much more going on here. The “solution” to the national student loan funding issue isn’t a single answer, but a series of near-term opportunities as we work toward a larger systemic change in how we understand higher education funding.

With the Reauthorization of the Higher Education Act (HEA) just 18 months away, the time is right to begin making real moves towards impacting the student loan issue in this country. To get there, we suggest that the following opportunities be explored:

1. Understand the entirety of the issue;
2. Explore policy changes to move us forward, which may be enacted as part of HEA;
3. Develop a repayment system that helps our former students who are struggling with their financial aid loan payments; and
4. Encourage our higher education institutions and the Department of Education to work together in educating and advising students on responsible borrowing.

Once these four topics have been explored, we’ll suggest that long-term, impactful change to the higher education funding system is only possible through moving our focus to measurable outcomes and connecting these outcomes to federal student aid dollars.

1. Understanding the entirety of the issue

There is more to the story of student loan over-borrowing than what is making headlines. And this story begins with one simple, but rarely talked about reality: students are borrowing more in federal student loans than the tuition net of grant funding, and taxpayers are often subsidizing expenses that are not necessarily tied to higher education.

But first, let’s back up and review the specifics of financial aid awarding. The Department of Education provides student loan funding in the form of Federal Stafford Loans to students, irrespective of credit worthiness. Undergraduate students can borrow Stafford funding up to set annual limits, which vary based on grade level. Dependent students, for example, can borrow $5,500 during their freshman year and $7,500 during their senior year, up to a $31,000 aggregate limit for their undergraduate career. Graduate level students can borrow $20,500 per year, up to an aggregate limit of $138,500 (these amounts vary for certain medical schools). The amount that a student can borrow annually for their program, graduate and undergraduate alike, is capped at the program’s “cost of attendance.” A program’s annual cost of attendance is based on a variety of factors, typically including tuition and fees, room and board (living expenses), loan fees, books, and sometimes things like transportation, dependent care, study abroad expenses, and disability expenses. In short, everything a student needs (and sometimes things he or she doesn’t need) in order to complete one year of higher education study.

The Department of Education only loosely regulates a program’s cost of attendance, mainly through providing a listing of “allowable costs,” and leaving it to the institution to determine the amounts to allocate in each category (typically determined through surveys, cost assessments and the like). At Capella, for example, our financial aid office annually reviews information from sources such as the College Board, the National Association of Student Financial Aid Administrators (NASFAA), and the Bureau of Labor Statistics to ensure reasonable and accurate figures are used in the construction of a program’s cost of attendance.

And so under direction from the Department of Education, schools develop the framework for financial aid eligibility for a student in a given program. Schools also, under regulatory requirements, provide prescribed loan entrance counseling (typically developed by the Department of Education) which informs students of the cost of borrowing federal student loan funds, their requirement to repay such funds, and the benefits of borrowing “responsibly” with regards to educational costs.

And then, financial aid offices send out award letters to students, requiring them to indicate just how much money they would like to borrow.

But this is the part of the story that we haven’t read about in the papers: the part where students decide how much they would like to borrow to cover their expenses during the course of the year, through an option which is much less expensive than credit cards. And the reality is, students often borrow more – sometimes much more – than what their tuition expenses are. They borrow to pay their rent, buy their books, order pizza on the weekend, and sometimes to take trips or upgrade their television, or even to access funds with which to pay off other forms of debt they may have taken on.

Let’s be clear: we are not blaming students for making these decisions, but instead drawing to light an issue inherent in the model that currently exists for federal financial aid, and making the case that the current framework can be improved. Based on financial aid rules, students can borrow up to the annual limit, based on their cost of attendance, with no credit check or requirement that the funds actually be spent on education expenses. And in fact, in sub-regulatory guidance the Department of Education reminds schools that they “cannot engage in a practice of originating Stafford Loans only in the amount needed to cover the school charges, or to limit unsubsidized Stafford borrowing by independent students,” essentially guaranteeing that students are able to borrow in excess of their need and that schools are limited in ensuring that students are only truly using Title IV aid for school-related expenses.

Borrowing in excess of institutional costs is happening across sectors in our nation. It is not a “for profit” or “community college” issue; it happens everywhere. Figure 1 shows data gathered from a Minnesota school in each sector – private non-profit (Hamline University), public (University of Minnesota), for-profit (Capella University) and a community college (Minneapolis Community and Technical College). Cost of attendance (COA) components are listed on the far left – tuition/fees, room/board, books/supplies, and personal expenses. What is most noticeable is that students at these schools have the ability to borrow anywhere from $7,000-$15,000 in excess of institutional charges for tuition and books, every single year. Between 22 – 72 percent of the dollars students are taking out “for college” are actually not subsidizing direct “college costs” at all.

As part of the Program Integrity rules published in 2010, schools with programs that lead to “gainful employment”, essentially all for-profit programs in addition to certificate programs at all schools, are required to post information in a prominent place on their website regarding average indebtedness of their graduates. A scan of the numbers on a variety of school’s sites highlights this exact phenomenon: average indebtedness for a program far exceeds the actual cost of tuition and books. And especially during periods of a declining economy, upside down mortgages, and job losses, students are, more often that we like to acknowledge, relying on federal student aid funds to pay for more than just their educational expenses. In fact, during the height of the recession in 2009, the Department of Education, in conjunction with the Department of Labor, encouraged any individual who was applying for unemployment benefits to also consider returning to school and applying for financial aid; they then delivered additional guidance to schools making these students immediately eligible for maximum federal loan and grant amounts.

At Capella University, despite graduate tuition costs which are lower than the average costs incurred at private non-profit institutions, this phenomenon of borrowing in excess of direct costs is as prevalent as it is anywhere. For example, the program cost of our doctoral programs averages $51,870 (approximately $7,400/year less than the average doctoral tuition charge at private non-profit institutions ). Factor in another $3,000 or so for books, and the actual educational cost of a terminal degree at Capella is around $55,000. When we look at the average amount of federal financial aid debt Capella doctoral learners take on in these programs, that number is approximately $85,000 (we’d also note that income data recently released Department of Education shows Capella graduates see a fast and meaningful payback on their degrees). This amounts to almost $30,000 in excess of educational expenses for these programs. Similarly, Capella’s Masters of Science students incur, on average, $24,979 in tuition costs for their program at Capella (approximately $9,800/year less than the average doctoral tuition charge at private non-profit institutions ) and another $1,900 for books. Yet these same students on average complete their program with $42,000 in federal financial aid debt associated with their degree, which is $15,000 more than the cost of the actual degree.

This is not to say that rising college tuition costs are not a problem and that schools shouldn’t actively focus on affordability and innovative options to drive down direct costs to students; in fact, we will devote an upcoming white paper to this exact issue. The issue in this conversation, though, is that a broad brush has been used to paint rising student loan indebtedness solely as a result of rising university costs, which isn’t the case. In fact, unless the problem of over-borrowing is addressed, even significant improvements in college affordability trends won’t do enough to address the student loan indebtedness issue.

2. Then, begin exploring policy changes to move us forward, which may be enacted as part of HEA.

Now that we understand the full extent of the issue, it is time to talk about potential policy changes that will allow for real, systemic changes to be made to our current system in order to help address the student loan over-borrowing issue. The solutions proposed below are options to explore within the existing Title IV system. Real, lasting changes can only be accomplished through a holistic overhaul of the federal financial aid funding system; which we will briefly address at the end of this paper.
The policy topics we will cover are:
a. Allowing schools to limit (on more than just a case-by-case basis) borrowing in excess of direct educational costs.
b. Limiting the amount schools can offer to cover living expenses to a standardized, state-specific amount.
c. Utilizing means testing as a way to determine financial aid eligibility.

a. Allow schools to limit borrowing in excess of direct educational costs.

As we discussed in the first part of this paper, schools are not permitted to originate and disburse financial aid funds to cover only direct costs incurred by the student. The issue of over-borrowing among our college students is happening in part because they are borrowing over and above their tuition and fee expenses and schools have no way to control this within the current financial aid system. In his white paper entitled “Borrowing in Excess of Institutional Charges,” financial aid expert Mark Kantrowitz used data from the National Center for Educational Statistics (NCES) to show that nearly one-third of college students are borrowing federal student loan funds beyond what is required to pay their tuition charges. Students are often borrowing above and beyond the direct costs incurred as a result of their educational experience to pay for living expenses, car payments and insurance, cell phones, television, and the like, and unfortunately schools do not have the authority to limit this borrowing. Mark Kantrowitz said, “The statutory authority requires that decisions to reduce loan amounts must be made on a case-by-case basis, as emphasized by the U.S. Department of Education guidance. The guidance indicates that colleges cannot have a policy or practice that routinely reduces loan limits. However, the U.S. Department of Education guidance goes beyond the statutory requirements to emphasize that students should be permitted to borrow for living costs, not just tuition and fees. Such guidance makes it difficult for colleges to reduce borrowing for any reason other than when a borrower exceeds the annual or aggregate loan limits or when a borrower is ineligible for federal education loans (e.g., when a student drops below half-time enrollment or fails to make satisfactory academic progress). College financial aid administrators would like to reduce loan limits to prevent students from graduating with excessive debt.”

These expenses, while technically covered by low-interest student loans, are a result of decisions that students make regarding what their four (or more) years of college will look like. By giving schools the authority to limit over-borrowing, the Department of Education can work alongside colleges to help enable real change in terms of the average student loan indebtedness among students. With this policy change, colleges would be able to help combat the phenomenon of excessive student borrowing.

b. Limit the amount schools can offer to cover living expenses to a standardized, state-specific amount.

Congress should consider enacting legislation which limits the amount that students are able to borrow in excess of direct educational costs. In an age of escalating student loan debt, taxpayers should not subsidize the cost of exorbitant dormitories, mortgage payments and the like. One option is to develop a living expenses cap by state for which a student may receive Title IV funds. Then, the cap can be tied back to a standardized methodology, such as census data based on the median monthly housing costs for renter-occupied units, and require schools to use the appropriate state data to determine Title IV eligibility amounts. A similar methodology can be used to account for meal plans and other expenses, and suddenly the story of student loan borrowing looks much different.

A great example of why this is so important exists right here in the Twin Cities of Minneapolis and St. Paul. Currently, on-campus apartment-style housing costs up to $8,002 for a 9-month period at the University of St. Thomas; almost $900/month for college living. Meanwhile, census data for Minnesota indicates that the median monthly rent for the state is $764. In the interest of finding ways to safeguard taypayer funds and ensure that Title IV financial aid is used for educational expenses, we would argue that there is some misuse occurring here.

At a minimum, the Department of Education could national survey of students regarding how they use their federal student aid funds. This would give visibility to how college students spend Title IV aid and the data would provide insight to this issue and also to help shape legislation that makes sense to the students who will eventually repay these loans, and to the taxpayers who fund the Title IV program. Then, the Department of Education can use this data to provide schools with more specific guidance, tied to a well-defined index, on appropriate limitations to cost of living allowances for students.

c. Utilize means testing as a way to determine financial aid eligibility.

The current means-testing method is the Free Application for Federal Student Aid (FAFSA), an annual document that a student (or a student and his/her parents) complete in order to determine which type/s of financial aid the student will qualify to receive. The output of the FAFSA is the Expected Family Contribution (EFC),an index number that is used not to determine necessarily how much financial aid a student will receive, but instead which type of federal aid the student is eligible for.

Students are eligible to receive federal financial aid, irrespective of income or credit-worthiness, up to annual limits, capped by a student’s cost of attendance. This means that a student who has minimal income and assets is eligible to borrow the same amount in federal loan funds as a student who has great wealth.

We believe the methodology used to determine federal financial aid eligibility should be altered to include an income and assets ceiling. In cases where the student’s income and assets hit this ceiling (perhaps where AGI exceeds possibly $250,000) a student would no longer qualify to receive Title IV funding up to their cost of attendance, but instead only to cover tuition and fees at the institution they attend. The additional expenses that these students incur in the form of living expenses, transportation, etc. should be paid by the student instead of using taxpayer funds to subsidize these costs.

The details of this proposal would need to be considered carefully. For example, the ceiling threshold for graduate students and dependent undergraduate students would likely look different than that for dependent undergraduate students (where a parent’s income/asset information is also considered), but the spirit of this proposed change remains the same: students for whom the federal financial aid methodology deems more than able to cover living expenses while in college should not be able to rely on federally subsidized taxpayer funding to do so.

3. Develop a more rational student loan repayment system.

The need exists to explore changes in Title IV policy that will allow current students and those who have yet to attend college a higher education funding system that is stable, sustainable and rational. But, the current loan repayment structure doesn’t work for many student loan borrowers. We know that college seniors who graduated in 2010 carried an average student loan debt of $27,000. Since unemployment continues to be an issue in this country, the ability for many former students to repay their loans continues to be a struggle.

Moreover, we know that taxpayers continue to invest in a federal financial aid system that has not provided an efficient and sustainable model for repayment. While federal student loans typically carry a lower interest rate and more flexible repayment terms, students who graduate with an abundance of student loan debt are given minimal options to discharge loans and in this way, it is the borrower and the taxpayer who are impacted. In the past year, President Obama has taken the first step to improve those repayment options as he expanded Income-Based Repayment to benefit more individuals in a higher salary bracket. Beginning this year, Income-Based Repayment is capped at 10% of discretionary income and loan forgiveness has been accelerated from 25 years to 20 years, a potential benefit to many individuals who have struggled to make their student loan payments each month.

But this isn’t sufficient when compared to the significance of the problem. For decades we have struggled as a nation to build a student loan system that is sustainable, and it’s no secret that we struggle with the one we have. Recent graduates with lower-paying jobs during the first couple of years out of college often simply do not make enough to pay their student loan payments. The existing alternative repayment plans require a significant administrative and paperwork burden on the part of the borrower and require documentation to be submitted each year in order to qualify for anything but a standard 10 year repayment schedule.

Instead, we could take a page out of the book of countries like Australia, New Zealand and the UK and adopt a student loan repayment process managed entirely through the tax system, which essentially eliminates defaults and links the repayment of student loans entirely to a borrower’s discretionary income. First proposed in 1955 by Milton Friedman, this model has students paying a fixed percentage of their income toward their student loans. This process would be managed by the IRS and these payments come right out of their paycheck each month. Borrowers with a higher income pay off their loans faster, while those with a lower income have a longer repayment period. Those borrowers who earn less than a certain fixed income threshold do not make any payments until their income rises, thereby ensuring that no one is crippled by their student loan payments. Then, after a period of time any remaining balance of the loan is written off.

Also, because the entire process is handled by the IRS, there is no paperwork burden to deal with. The IRS would immediately adjust the payments based on one’s income, over the repayment of the loan. There are no hurdles to clear or student loan collection departments trying to track down borrowers for their payments. And for students, their repayment is made easier through an automatic debit process instead of relying on the individual to responsibly save a portion of each paycheck. This takes the necessity of planning out of the equation. Best of all, this model ensures loan repayment by borrowers that does not also threaten home buying, saving for retirement, etc. and taxpayer funds are better protected.

4. Encourage our higher education institutions and the Department of Education to work together in educating and advising students on responsible borrowing.

Understanding the extent of the issue and enacting policy changes to address the existing system have the potential to have a sizeable impact on the student borrowing issue, but there is also work to be done by higher education institutions and the Department of Education. These entities need to work together to enhance education and information dissemination to current and prospective students in order to ensure that students who borrow are not surprised by their payments following graduation.

Currently, the Department of Education requires loan counseling when students borrow their first loan and then again at any point in which the student drops below half-time enrollment; for many students, that is the extent of the information they receive. Any supplemental financial literacy with regards to student borrowing is voluntary and generally comes from the school (a recent study by National Economic Research Associates [NERA] Economic Consulting suggests that 80% of borrowers receive at least some of the information regarding their student loans from their school’s website or financial aid counselors ), including notifying students when they are nearing their aggregate lifetime limit for borrowing through the federal loan program. Studies regarding student loan borrowing suggest that there is significant improvement needed to educate students on the reality of just how much they borrow. NERA’s research indicates that 65% of student borrowers “misunderstood or were surprised by aspects of their student loans or the student loan process,” despite having received entrance and exit loan counseling. Clearly, this indicates that the information being provided to students as they borrow is not resonating enough to ensure that students understand the details around their responsibility regarding student loans, and that much more robust financial literacy needs to be provided to these borrowers. As NERA suggests, this needs to be a group effort,

“But this survey suggests there is also a severe shortage in “preventive” measures taken by schools, lenders, legislators and regulators, and consumer advocacy organizations to ensure that borrowers are provided with key information upfront so they understand their rights, obligations, and available options. The results of this survey indicate that it is more important than ever for these parties to work together …”

The responsibility to prevent over-borrowing in every form lies with all key stakeholders involved in federal financial aid. Therefore, these groups need to work together and all entities need to proactively inform students about the reality of borrowing to finance their education, all options available to students, and what borrowing now may mean for students once they complete their studies.

Another way to help address this issue is through standardization of financial aid award letters for students in order to help reduce confusion and streamline the presentation of financial resources to students regardless of which institution they attend. In a 2010 Fastweb survey of college students and their parents, it was found that the lack of standardized requirements in award letters has the potential to be misleading students regarding college costs. “The most problematic of these practices understate the college costs, overstate the generosity of the financial aid package and obscure or misrepresent the true bottom-line cost of college. Cost of attendance information is often incomplete or absent.” Given this need, we strongly suggest that Congress pass the “Understanding the True Cost of College” Act proposed by Senator Al Franken earlier this year. This proposed legislation would not only reduce confusion among students, but also paint a clear picture of the amount of debt required by the program in order to graduate, so students can in no way confuse gift aid with borrowed funds. Until we are able to present students with a true comparison of the schools and the investments they are considering as they choose a college, confusion will continue to exist in the higher education arena.

Finally, schools need to do a better job self-policing when they provide visibility to students of the reality of their student loan borrowing decisions, and also as decisions are made regarding a student’s cost of attendance. Schools should at least do a thorough annual review of the amount of financial aid students are able to receive to cover living and personal expenses. Gainful employment-type disclosures regarding median debt and cost information needs to be prominent and easy to find on any school’s website, and all schools should post this information in an easy to find, easy to understand format. For example, at Capella we built our Capella Results website which is provides visibility on financial, outcomes and student satisfaction data. Schools should update students annually on their student loan balance (including cumulative debt to date, projected debt at graduation, and the corresponding monthly loan payment amounts) and how that translates into a monthly payment. Schools should also offer financial literacy courses to students at no cost in order to ensure that students understand the importance of making responsible financial decisions. At Capella, we offer a no-credit financial literacy course to both our undergraduate and graduate students at no charge. There are Title IV policy changes that can be made to help address the student loan over-borrowing issue, but schools also have a responsibility to their students and taxpayers to ensure that enough is being done to equip students with the information they need.

True Financial Aid Reform: The Outcomes Conversation

The policy solutions we have put forth thus far are only first steps toward a comprehensive overhaul of a higher education funding system to better meet the needs of students, taxpayers and schools. The real, long-lasting solution is to begin to utilize the data necessary to build a system that focuses on outcomes and student achievement. As we argued in our first white paper, critical accountability data about student completion and progression, debt levels and career outcomes can be made available and transparent through thoughtful public policy.

We don’t have this data available to us yet, so is difficult to pinpoint exactly what this new way of awarding and disbursing financial aid could be, but we have some ideas. One potential solution is to move to an outcomes-based funding system that ties financial aid to student progress, where students don’t receive federal financial aid until they successfully complete their course. Therefore, we ensure that educating our students is paramount and that students are continually moving towards the completion of their degree. A similar type of model has been promoted by MDRC and their Performance-Based Scholarships, in which private funding is tied directly to student outcomes and is “paid contingent on attaining academic benchmarks. Unlike merit-based aid, performance-based scholarships focus on current and future performance rather than earlier accomplishments.” To be clear, we feel that this kind of approach must be predicated on an improved system on outcomes measurement that does not yet exist.

Another option is that we build in significant repayment incentives to students who complete their degree. Perhaps these borrowers get part of their student loan debt forgiven or are given more favorable interest rates on their loan balance. Or, perhaps the system ties federal financial aid dollars to outcomes at the institution level, ensuring both measurable outcomes and the delivery of a quality academic product. In this model, institutional innovation is rewarded and schools are incented for moving students through their educational programs successfully.

There are many details to be determined for model like this, but it is necessary if we are to evolve with the direction education is heading, and if we are to truly build a funding system that ensures long-term success. The current model, while it provides the necessary access that will continue to be critical to American competitiveness, does not drive the optimal results because we do not have the necessary data.

As we mentioned in our first white paper, the first step is to collect data, the right data, and to use it in ways that make sense across sectors and schools. By gathering and providing access to outcomes data, the Department of Education can not only foster innovation, but the entire higher education funding model can be tied back to the things that really matter: successfully moving students through post-secondary education in order to produce capable graduates. Capella is willing and eager to participate in these conversations and to help shape the future of higher education via an outcomes-driven delivery method. We believe that it is the best way to both promote college affordability and ensure the delivery of quality academic offerings.

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