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Government Proposes Changes to Federal PLUS Loan Credit Criteria

The U.S. Department of Education is proposing to loosen the eligibility criteria for the PLUS Loan, after previously tightening them.

Current Regulations

To be eligible for a Parent PLUS Loan or a Grad PLUS Loan, the borrower must not have an adverse credit history. The term adverse credit history is defined in the current regulations as a borrower with a current delinquency of 90 or more days or certain derogatory events, such as bankruptcy discharge, foreclosure, repossession, tax lien, wage garnishment or default determination, within the last five years.

Operational Changes

In October 2011, the U.S. Department of Education added two new criteria that doubled the PLUS Loan denial rate. The additional criteria excluded borrowers who have an account in collections with a non-zero balance or who have an account that was charged off with a non-zero balance. The additions were made without notice to colleges as required by the Higher Education Act’s master calendar provisions. The additions also were not made according to the normal regulation-setting process, but instead were described as “operational changes” by the U.S. Department of Education.

But these changes cannot be considered operational changes, as they conflict with a plain-language reading of the existing regulations. The existing regulations would not have included language concerning write-offs of Title IV debt if any charge-offs were considered to be evidence of an adverse credit history. Likewise, the existing regulations would not have included language concerning default determinations if an account in collections were sufficient to consider a borrower as having an adverse credit history.

Proposed Regulations

To address the flawed process used to make these changes, the U.S. Department of Education is now taking the proper steps required to change federal regulations. The U.S. Department of Education just published a Notice of Proposed Rulemaking (NPRM) that proposes new regulations after negotiating with various stakeholders concerning a draft of the new regulations.

The NPRM encodes the new criteria in the regulations, but limits them to debts with a total combined outstanding balance of more than $2,085 that have been placed in collections or charged off within the last two years. The $2,085 threshold will also apply to the 90-day delinquency criterion. This replaces a previous $500 threshold that was used during the appeals process, per the regulations at 34 CFR 685.200(c)(1)(vii)(D). The choice of the $2,085 threshold is arbitrary, based on the estimated median debt level for loans that are charged-off, in collection or 90+ days delinquent, rather than any definition of significant debt. Based on data from the 2011-12 National Postsecondary Student Aid Study (NPSAS), 94.3% of Federal Parent PLUS loan borrowers and 96.4% of Grad PLUS Loan borrowers borrow more than $2,085 in PLUS Loans per year.

The new regulations will also require loan counseling for borrowers who have an adverse credit history but successfully appeal a denial based on extenuating circumstances.

The U.S. Department of Education estimates that 370,000 of the 1.1 million loan applicants who were denied a PLUS Loan in 2012-13 would have been approved under the new criteria, increasing the number of annual PLUS Loan approvals by about a third to 1.5 million.

Flaws in the Proposed Regulations

Nevertheless, the new adverse credit criteria still suffer from serious flaws:

  • There is no evidence that these changes will reduce PLUS Loan default rates. So, the changes may be needlessly denying PLUS Loans to borrowers who are capable of repaying the loans.
  • The proposed regulations are backward-looking, considering only evidence of past financial difficulties. They do not consider any evidence of current or future ability to repay the debt, such as debt-to-income ratios, minimum income requirements or credit scores. So, the regulations may allow applicants who are incapable of repaying the loans to qualify for PLUS Loans.
  • The proposed regulations do not include any exceptions for medical debt, which generally does not affect the likelihood that a consumer will repay other debt.

These regulations will permit applicants who are clearly incapable of repaying debt, such as applicants with no income, to borrow from the Federal PLUS loan program. For example, analysis of data from the 2011-12 NPSAS demonstrates that Parent PLUS Loan borrowers with adjusted gross income (AGI) under $16,000 have a debt-service-to-income ratio greater than 15% and a debt-to-income ratio greater than 100% (1:1). These parents, who represent about 18% of Parent PLUS Loan borrowers, are borrowing more for just one child’s education than they can currently afford to repay. The parents are at very high risk of defaulting on the Parent PLUS Loans if their income doesn’t improve or someone else doesn’t help them with the loan payments. These borrowers will continue to be eligible for Parent PLUS Loans if the draft regulations become final.

A Better Approach

Parent PLUS Loan borrowers should borrow no more for all their children than they can afford to repay in ten years or by retirement, whichever comes first. If total Parent PLUS Loan debt is less than the parent’s annual income, the parent will be able to repay the loans in ten years or less. If retirement is only five years away, the parents should borrow half as much.

Parent eligibility for a Parent PLUS Loan should be modified to prevent borrowers from taking on unaffordable debt by using credit criteria that identify borrowers at high risk of default. Such borrowers can be identified by considering debt-to-income ratios and debt-service-to-income ratios. The eligibility criteria should also prevent borrowing by parents whose income is below the poverty line. Student financial aid to low-income students should be in the form of grants, not loans. College grants should be increased sufficiently to eliminate the need to borrow for students enrolled at in-state public colleges.

The U.S. Department of Education, however, argues that consideration of a borrower’s ability to repay would require an amendment to the Higher Education Act of 1965 because the word “history” in “adverse credit history” limits the consideration to past performance in repaying debt, not future ability to repay a specific level of debt. Yet, this is inconsistent with the regulations at 34 CFR 685.203(c), which permit a dependent student to qualify for additional unsubsidized Federal Stafford loan limits if the student’s parent is unable to repay the debt (e.g., if the student’s parent receives only public assistance or disability benefits). One can argue that the word “adverse” enables the use of forward-looking analyses of the credit history given the definition as “preventing success” (Oxford English Dictionary) in the same sense as “adversary” as opposed to being synonymous with “unfavorable” or “negative.”

Public Comments on Proposed Regulations

The public may comment on the proposed regulations at using Docket ID number ED-2014-OPE-0082 through September 8, 2014. To be most effective, public comments should contain substantive criticism of specific provisions of the proposed regulations, not just statements of support or opposition to the proposed regulations.

It is expected that the final regulations will be published by November 1, 2014 and will be effective on July 1, 2015.