The widening subprime mortgage crisis has snared another traditionally safe corner of the credit markets: student loans. Many parents and students lining up college financing this spring will find fewer companies offering loans and, for private loans, more stringent lending criteria and higher interest rates and fees. Most affected will be students like Lauren Dean, a sophomore at the University of North Texas who uses private loans to bridge the gap between tuition costs and low-interest government loans. She says the 8 percent interest rate on her private loans is already too high.
Unlike federal loans, whose interest rates are capped by law, private loans—offered through banks, credit unions, and other lenders—typically charge variable rates tied to credit scores. Students taking out these loans could see their rates rise by half a percentage point to a full point, says Robert Shireman, executive director of the Project on Student Debt.
Why are private loans feeling the pinch? Like mortgages, some student loans are bundled and sold on a secondary market, where they are used to fund new loans. But skittish buyers aren't biting, and some lenders are having a hard time raising enough cash to keep making loans. "Unlike with federally backed loans, no one is serving as the backstop for defaults, so investors are worried that these bundles of loans won't turn out to be safe," Shireman says. Meanwhile, lenders are also coping with a new law that limits federal subsidies on government-backed loans. As a result, some lenders, such as College Loan Corp. and Nelnet, have scaled back on the types of loans they offer. Others have taken more dramatic action: In mid-February, the Michigan Higher Education Student Loan Authority, a state agency, said it would suspend a private-loan program "due to the current and unprecedented capital-markets disruption."
Growth spurt. Private loans are the fastest-growing segment of the student-finance market. In 2005-06, students took out $17.3 billion in private loans, compared with only $1.3 billion a decade earlier, according to the College Board.
Aside from raising interest rates, lenders of private loans are toughening their standards. The nation's largest student lender, Sallie Mae, recently announced that it's no longer providing private loans to students whose credit ratings are below prime. Lenders are likely to require a credit score of at least 650 to secure a private loan, up from a previous requirement of 620, says Mark Kantrowitz, publisher of financial-aid website FinAid.org. Students with no credit history will also run into roadblocks. "A 20-year-old with no credit and no cosigner is going to find that rates will be quite a bit higher," Shireman says.