A common misconception with student loans is that they perform badly. Despite the fact that students often have little to no established credit history and may be short on cash, student loan default performance has continued to improve over the past 12 to 15 years. As is outlined in the table below, the Department of Education published the Federal student loan cohort default rate to be 15% in 1992, but after many years of steady decline, the cohort default rate was reported to be 4.6% in 2005, at the lowest levels in recent history.

⁽¹⁾ Source: Department of Education.
Once per year, the Department of Education publishes its official Cohort Default Rates based on the percentage of a student borrowers who enter repayment on Federal student loans during a federal fiscal year (October 1 - September 30) and default before the end of the next fiscal year.

The default data outlined above is for Federal student loans. Federal loans are available to each and every student that enrolls in an accredited institution and fills out the Free Application for Federal Student Aid (FAFSA). An important consideration is that in the Federal loan program, the student's credit profile is not taken into consideration and a cosigner is not required. Students (mostly) do pay them back!

Private student loans, such as those provided by Fynanz, are used to bridge the shortfall between the cost of education and the limited amount of Federal loans available to students. Private loans are credit instruments – each borrower undergoes an underwriting process by the lender, where the borrower's credit profile is taken into consideration. If a student borrower does not have an established, strong credit history, as is the case with many undergraduate students, a cosigner (typically a parent) is required by the lender.

Defaults on private loans are generally lower than Federal loans given the credit underwriting process and criteria (i.e. credit check and required cosigner). Based on recent data, the cumulative lifetime default rates on private student loans range between 7.0% and 8.5%⁽²⁾, versus approximately 10% for Federal loans.

⁽²⁾ Source: Sallie Mae and First Marblehead.

Oftentimes, when mentioning student loan defaults, default rates are discussed that vary greatly. You may have seen them reported as 1%, 10% or even 15%. How could student loan default behavior be so different? All these numbers are correct, it just depends how they are used, here's why:

• Student loan defaults tend to be front-loaded. Students are given many years to repay their loans (typically 10-20 years once they enter repayment after graduation). However, students that default usually do so within the first 4 to 5 years once they enter repayment. The likelihood of a student defaulting decreases substantially once they make it past the first 4 to 5 years after graduation.
• Cumulative defaults are approximately double the Cohort Default Rate. The cohort default rate published by the Department of Education is calculated over a two year period from the time a student graduates and begins repayment. Given the majority of defaults usually occur in the first 4 to 5 years after graduation, the general rule used to estimate the lifetime cumulative default rate is to double cohort default rate. Therefore, the 2005 cohort default rate of 4.6%, which was released in 2007, results in an expected lifetime cumulative default rate for a portfolio of Federal student loans to be 9.2%. This result is very close to the 10% that is sometimes reported.
• Banks often annualize default rates. The 9.2% cumulative default rate represents the defaults over the life of a portfolio of loans, and is not an annualized number. Some lending institutions report defaults as an annualized number for accounting purposes. Federal student loans with all the deferment, forbearance, and consolidation features can be repaid over a 10 to 20 year time horizon. However, the weighted average life of a Federal loan portfolio is approximately 9 years. Therefore, if the 9.2% cumulative default rate is divided by the 9 year weighted average life, the annualized defaults equal approximately 1% per year.

So, the same data may be reported in different ways. A 10% default rate sounds high, if you confuse it to be 10% per year instead of 10% cumulative. And a 1.0% default rate sounds great, if you don't realize it is an annualized number. As for the 15% default rate – well, it's the first number in the chart above and dates back to 16 years ago to 1992.

Note: Cumulative default rates give the most accurate picture of defaults.

The Department of Education reports historical default experience for each type of academic institution. Typically, four-year undergraduate institutions experience lower default rates compared to two-year colleges and for-profit trade schools. To mitigate risk, many private lenders avoid offering loans to students attending two-year or for-profit schools. However, a large number of two-year colleges and trade-schools have default rates in line with four-year institutions given the strong academic attributes of certain students attending these institutions. Therefore, Fynanz believes select students attending these schools should have access to our marketplace.

To develop the Fynanz Academic Credit Score (FACS) we analyzed 15+ years of student loan default studies and performance data. We concluded that while the type of academic institution a student borrower attends does correlate to the default rate, other academic factors (i.e. student class standing, course of study, & full-time vs. part-time enrollment) are a much better predictor when determining the likelihood of borrower default.

In order to better gauge the risk of default, Fynanz not only checks the borrower's credit profile, but also analyzes the academic characteristics of all potential borrowers. Below is a summary of the main academic factors Fynanz believes have a strong correlation to preventing default. Fynanz takes into account each of these factors when determining the FACS Grade for each loan application.

• Academic institution admission requirements and graduation rates. Schools with higher graduation rates and more selective admission criteria (i.e. higher required SAT scores, high-school GPA to gain entry) tend to have lower cohort default rates and therefore lower cumulative default rates.
• Borrower class standing. Graduation is the single-most important predictor of borrower default – regardless of the school, GPA, or program of study. As a student get closer to graduation the likelihood of graduation increases and the chance of default decreases. This is the primary reason Fynanz allows eligible juniors and seniors without a negative credit profile to apply for up to $7,500 per year without a cosigner. A graduate is 10 times less likely to default versus a freshman who drops-out.
• Level of Study (undergraduate vs. graduate studies). Students in graduate programs are approximately 50% less likely than undergraduates to default.
• Full-time vs. half-time students. Compared to part-time students, students that are able to make the commitment to focus on studies full-time tend to have a greater chance of graduating, excel in academics, and obtain higher paying jobs after graduating.

If you would like more detailed information, Texas Guarantee (a Federal Student Loan program guarantor) has put together a summary of research on student loan defaults, which can be found at www.tgslc.org/pdf/default_lit_review.pdf.

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