As college-bound minorities take a step toward self-improvement, lenders could be sending them two steps back.
Lenders rely on complex, and at times secret, methods of determining what rate to charge a borrower for student loans. Some lenders, including the credit giant Sallie Mae, look at the borrower’s school to find out how many of its students have defaulted on their loans—and then factor that into the equation determining a specific borrower’s interest rate. The result may be a significant increase in the interest rate and fees on a student loan based partly on what school the student chooses to attend.
One problem with the use of so-called “cohort default rates,” as the U.S. Department of Education calls the statistics it requires schools to keep, is that some racial minorities default on their loans at disproportionately high rates. One analysis of federal data found that black students “had an overall default rate that was over five times higher than white students and over nine times higher than Asian students.” Hispanic students defaulted at twice the rate of white students and at quadruple the rate of Asian students.
The result could be a vicious cycle. Schools with high cohort default rates tend to serve disproportionately large minority and low-income populations. Students who attend those schools, in turn, may be charged higher interest rates. The practice, highlighted in 2007 by New York Attorney General Andrew Cuomo, prompted Sens. Patty Murray, D-Wash., and Christopher Dodd, D-Conn., to introduce legislation last summer that would have barred such a practice. It didn’t pass, and there is no sign that the credit industry has renounced the method. Congress did, however, order a study of the effect that such practices have on the cost of private student loans.
Practices that have a disparate impact on minorities may violate the Equal Credit Opportunity Act, a federal law designed to protect minorities from lending practices that treat minority groups unequally in credit markets.
The problem may be especially acute at schools such as community colleges that have elected not to participate in federal loan programs. Lower income and minority students are more likely to be among the more than 1 million students attending such schools. Student loans are accordingly much less accessible by racial minorities than by whites. Minorities must rely more heavily on expensive private loans and are at the mercy of a lender’s fuzzy math.
The stakes for minorities trying to navigate the already tumultuous waters of today’s recession are only going up. Defaults among low-income and minority students may rise as a growing number of new college students will be from their ranks because of demographic shifts and their efforts to boost their competitiveness in tight job markets.
The question is how long minorities will be charged more for their education simply because the schools they choose to attend serve more people who look like they do.
*This blog was written by our summer law clerk Cory Reiss, a rising 3L at Wake Forest University School of Law*