A recently published report from the federal government highlighted trends in student borrowing from private lenders that included significant variability during the years of economic growth and recession, drawing comparisons to the subprime mortgage crisis.
The findings of the report, published by the Consumer Financial Protection Bureau, included that student borrowing from private lenders “rapidly grew” from $5 billion in 2001 to $20 billion in 2008, followed by a “precipitous” decline to less than $6 billion in 2011.
Private lenders, the report states, “loosened” their approval standards during the period of national economic growth when private borrowing increased. The percentage of private loans made without approval from the students’ schools increased from 40 percent to 70 percent between 2005 and 2007. During that same period, private lenders were more likely to lend to students with lower credit scores. These changes, according to the report, “made private student loans riskier for consumers.”
Shortly after the beginning of the recession, in 2008, defaults on student loans rose dramatically. Today, 850,000 student loans have defaulted, representing a cumulative $8 billion. Although the report acknowledged that an increase in defaults may be part of the recession, it also said these defaults may be related to “over-borrowing and the level of subprime credits in cohorts like 2007.”
Even though comparisons were drawn to a mortgage crisis that had international economic implications, officials from the Bureau focused on the impact of the lending on students.
“The impact of the economy is that many are facing high debt burdens. Many say that is preventing them from saving up for a home and other economic milestones,” said Rohit Chopra, student loan ombudsman at the Bureau.
A relatively small amount of students — 14 percent undergraduate and 11 percent graduate — take out private loans to finance their education. Most draw first from the over $97 billion in subsidized and unsubsidized loans offered by the federal government every year, according to a report by the College Board. Federal loans offer special protections for students including subsidized and fixed-interest rates, deferment options, forbearance and income-based repayment. Some have said that students are not aware of these special protections offered by these loans.
The UC advises undergraduate students to maximize other resources, including federal loans, before seeking out private loans, warning that they may reduce eligibility for free or lower-cost federal, state or school-based student financial aid.
“We have data that shows at the height of the market, students were not taking out as much as they could in loans”, said Matthew Reed, program director at the Institute for College Access and Success.
Reed said that in one of the institute’s reports it was found that students and parents reported that they assumed they did not qualify for loans or did not understand the difference between fixed and variable-rate loans.
“It is clear that there is misinformation in taking out private loans,” Reed said.
The Bureau enumerated several policy recommendations in the report, including ensuring that students are properly informed of their loan choices before they sign a promissory note. Some of these recommendations include requiring certification of private loans — whereby loans would be approved by educational institutions — before disbursement and the creation of a centralized system where public and private loans can be compared side-by-side.
In the last four years, private lenders have tightened up their lending standards. In 2011, over 90 percent of private student loans were co-signed, an increase from 67 percent in 2008. Nine out of 10 private student loans for undergraduates in 2011 required that the school certify the student’s need for financing. Credits score checks have also increased with stricter criteria for approval.
Two of the largest private lenders for education, Wells Fargo and Discover, responded to the report by pointing out the relatively small portion of student debt that comes from private loans and the protections that both lenders have in place to protect consumers. Both organizations said private loans offer variable interest rates at a competitive rate because of a current low-interest rate market.
“We support the education secretary’s call for resources to build a comprehensive picture of the student loan landscape that included both private and federal student loans for a more accurate picture of the challenges that need to be addressed,” said Discover spokesman Jon Drummond.