* Default rates must be below 35 percent to keep aid
* Five percent of programs could be ineligible
By Diane Bartz
WASHINGTON, June 22 (Reuters) - For-profit education companies could soon have to prove that their former students are either paying off their loans or capable of doing so, the Department of Education said on Thursday.
The proposal has for months weighed on stocks in the sector including Apollo Group Inc (APOL.O) and DeVry Inc (DV.N), as it could cut off access to federal funding for some types of training.
The proposed rule is part of a broader overhaul of the industry, which has been criticized for producing poorly prepared students with big debts.
The Education Department issued on June 15 a series of other rules that required the schools to give prospective students their graduation and job placement rates. The schools are often aimed at lower-income or minority students.
But the department left the toughest rule for last -- the monitoring of federal loan default rates -- which could lead to a crippling loss of federal funds, and therefore profits.
Education Secretary Arne Duncan predicted that five percent of programs would lose those funds.
"Ninety percent of revenues in many for-profit schools come from student loan programs," Duncan told reporters on a conference call, adding that default rates approached 25 percent.
"Strong career colleges should welcome our proposal," he said. "Overall I firmly believe that for-profit schools are doing a good job of training their students."
The Career College Association, representing 1,500 schools, 95 percent of which are for-profit, said the Department of Education proposal "is unwise, unnecessary, unproven and is likely to harm students, employers, institutions and taxpayers."
"Amounts borrowed today do not indicate what you will be able to repay in five years, ten years or over a working lifetime," CCA President Harris Miller said in a statement.
Programs would lose their eligibility if more than 65 percent of former students failed to pay the principal on federal loans, and if their graduates' debt was more than 30 percent of discretionary income and 12 percent of total income, the department said.
Schools would be declared fully eligible for loans if they can show that 45 percent of former students are paying down their debt, or that their debt is less than 20 percent of former students' discretionary income or 8 percent of total income, the department said.
Other schools would fall into a middle ground and may have to warn students about incurring heavy debts, the department said.
The rules are subject to a 45-day comment period, and are slated to go into effect for the 2012-2013 school year, officials said.
The schools, which offer higher education programs in fields like healthcare and criminal justice, have come under increased scrutiny for their student loan practices and the quality of their education services.
Seventy percent of the Education Department's investigations are into problems at for-profit schools, department inspector general Kathleen Tighe told the Senate's Health, Education, Labor and Pensions Committee recently.
Fifty-three percent ended up owing more than $30,500, compared with 12 percent for students who attended a public four-year college, according to a study by the College Board.
The for-profit education business can be lucrative.
Apollo Group Inc posted better-than-expected quarterly results in late June, helped by 13 percent growth in enrollments at its University of Phoenix. It forecast revenue growth in the high single digits in fiscal 2011.
Other companies in the sector include ITT Educational Services Inc (ESI.N), Corinthian Colleges Inc COCO.O and Career Education Corp (CECO.O). (Reporting by Diane Bartz; Editing by Tim Dobbyn and Bernard Orr)