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Founder, CFP® Joel Ohman

UPDATED: Feb 8, 2013

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Student loan borrowers are used to creditor calls, but what happens with the university itself comes after you?

George Washington University (GWU), Yale University, and the University of Pennsylvania (UPenn) have all filed recent lawsuits against former students who defaulted on their Perkins loan payments.

One student is Kyle Lopinto who owes the University of Pennsylvania $7,000 in Perkins loans and $15,607 in unpaid tuition and legal fees. The case, University of Pennsylvania v. Lopinto, was filed in November 2012.

According to court records, UPenn filed over a dozen Perkins student loan lawsuits last year.

Another student is Aaron Graff, who graduated from GWU in 2010. According to court documents, he defaulted on $4,000 in Perkins loans. A formal lawsuit, George Washington University v. Graff, was filed in May 2012.

The Unique Perkins Loans

Michelle Sherrard, Director of Media Relations at GWU, told that it is not university policy to comment on specific lawsuits.

However, Sherrard did specify part of the reasoning behind the suits.

“It should be noted that Perkins Loans are issued from a revolving fund so any monies recovered through litigation increase universities’ ability to help other students with education loans,” Sherrard said.

Perkins loans differ from other federal and private student loans. Perkins loans, primarily given to low-income students, are dispersed by the college or university itself, not the federal government as other forms of federal loans are.

Due to this process, they are not categorized under the income-based repayment options offered by the federal government. This means that each student is expected to repay their entire Perkins loan debt themselves.

Each school’s Perkins loan fund is revolving — depleted and replenished by the new and existing loans. When a school’s Perkins loan fund diminishes due to non-repayment, it can inhibit the school’s ability to distribute new loans for upcoming students.

Most of the universities involved in the lawsuits have large endowments. Yale has an endowment of $19.3 billion, followed by the University of Pennsylvania’s $6.8 billion and GWU’s endowment of $1.33 billion.

John Whitlock, partner at law firm Edwards Wildman Palmer, said a school’s large endowment fund does not grant it unlimited access to loans.

“Even a school with a large endowment does not have unlimited resources for student loans and scholarships, and so preserving the funds in the Perkins program can be reasonably seen as proper stewardship of these funds,” Whitlock said.

Regardless of the lawsuits, the overall impact of Perkins loan defaults, in relation to the overall student loan debt, is minimal.

Federal student loans have a lower default rate than private student loans. Whitlock said the default rate at Yale and similar schools is very low.

“If top schools are bringing suits to collect loans it probably means that administrators are seeking to preserve as much money as possible for their loan programs, and are resorting to suits to do so,” he said.

Sherrad said GWU considers litigation “a last resort” because students are given multiple opportunities to repay the loans before the university files a lawsuit.

However, Whitlock believes that the shift to litigation is a symptom of a larger issue.

“I would treat it as a symptom that default losses have increased to the point where the schools feel they need to take more aggressive action to get defaulting students to find the resources to make payments,” he said. “It may also be a symptom that even graduates of top tier schools are carrying too much debt in relation to their job prospects.”

Whitlock said due to the increase in default rates, and the still struggling economy, more legal suits are likely to follow.

Evolution of a Problem

During the early years of the student loan program, Whitlock said there were reported cases where a student would file for bankruptcy after college, have their debt discharged and then move on to finding a job.

Whitlock said this “outraged” the lenders and they were forced to pass legal measures which first limited the dischargeability of federal student loans and eventually all student loans. The “undue hardship” standard was enacted early on to limit the number of student loan debts that could be absolved in bankruptcy. It also allowed for borrowers that were truly unable to repay their debts to get out. In the 2005 amendments to the Bankruptcy Code, the “undue hardship” standard became one of the most difficult barriers to overcome and severely limited the number of successful bankruptcy applicants.

But some critics are less worried about debt absolution and instead are more concerned with the amount given to students in the beginning.

“Perkins loans are a small fraction of the total student debt,” Whitlock said.

Unless financially backed by parents, most students entering college have little to no credit to their name. Unlike other forms of loans where a stable credit history is necessary, higher education loans are approved regardless of a borrower’s ability to repay.

Whitlock said the student loan market could become limited in the future, similar to the mortgage market of today, where borrowers with poor credit may find it difficult to get a loan.

“The policy to make higher education affordable for as many students as possible, like the policy to encourage home ownership, has lead to an expansion in the amounts made available to borrowers,” he said.

But the spike in the higher education economy could cause disastrous effects in the near future. Student loans that are left unpaid could reduce the available funds for future student borrowers.

 “Schools, students, and their parents are beginning to realize that borrowing must match the reasonable expectations for repayment, but there is still a very strong policy to encourage as many students as possible to go to college,” he said. “Eventually … our society will have to decide how much money we will make available that can never be repaid.”