"Private Student Loans," the July 20th report from the Consumer Financial Protection Bureau (CFPB) to Congress, is data-driven and understated. It is also compelling and holds the feet of the private loan industry to the fire.
The most important information for borrowers and their families concerns the riskiness of private student loans and the difficulty distinguishing between private and federal loans. Nearly all private loans mimic key features of federal Stafford loans: They do not require borrowers to pay in school, offer a six-month grace period after graduation, and offer further deferment if a borrower returns to school. Unfortunately, these superficial similarities mask significant risks.
Private loans have variable interest rates and risk-based pricing that are not disclosed to borrowers until the lender approves the loan. Only a small percentage of borrowers—those with the best credit or whose cosigners have the best credit—actually receive rates comparable to federal Stafford loans.
In addition, private student loans almost completely lack protections like income-driven repayment plans, forbearance, and even the ability to rehabilitate defaulted loans.
[Learn about federal student loan repayment plans.]
The report concludes—and the Student Loan Ranger agrees—that federal loans are a better choice for the vast majority of borrowers. The very few borrowers with the financial means to pay off their entire loan if they need to may find it worthwhile to take out private student loans. For everyone else, private student loans are a gamble.
Another fascinating story told by the data is of the boom and bust in private student loans during the last decade. The private student loan market (at least the vast majority of it dominated by financial institutions) grew from less than $5 billion in 2001 to more than $20 billion in 2008, and then crashed to less than $6 billion in 2011. The boom was fueled by the rise of asset-backed securities, which pushed all the risk that a borrower might default onto the buyer.
Private lenders increased borrowing by creating "Direct-to-Consumer" lending that reached borrowers via advertising and, crucially, circumvented financial aid offices where borrowers' eligibility for federal loans, scholarships, and other non-federal aid that might make more sense could be brought to their attention. In addition, lenders significantly weakened credit standards.
Post-boom, as the demand for student loan asset-backed securities fell dramatically and lenders were forced to retain the majority of their own student loan portfolios, they rapidly changed course and took steps to reduce risk.
By 2011, 90.5 percent of loans required a co-signer (compared to 55 percent in 2005), mean credit scores had increased, school certification was at its highest level, and lenders were again returning to disbursing funds to schools instead of borrowers.
[Read about common private student loan complaints.]
Unfortunately, the millions of Americans currently holding $150 billion in outstanding private student loan debt are in far more perilous financial positions due to these actions. And the economy is not helping. The 2009 unemployment rate for private student loan borrowers who started school in the 2003-2004 academic year was 16 percent.
It's not a big surprise that default rates have spiked since the financial crisis of 2008, that the cumulative defaults on private student loans exceed $8 billion, and that the monthly student loan payments of 10 percent of recent college graduates are more than 25 percent of their income.
"Private Student Loans" contains a series of recommendations to Congress. The Student Loan Ranger supports all of them, especially the proposals to examine the current bankruptcy discharge standard (student loans are not dischargeable in bankruptcy), protecting and informing borrowers, and determining how to afford greater flexibility and relief to private student loan borrowers who are experiencing financial distress.
The Student Loan Ranger would add removing the current limits on undergraduate federal loans, which would ensure that private lenders always have to compete against federal products and that all students would have access to the full panoply of protections offered by federal loans.
The Student Loan Ranger also urges Congress to enact these reforms before the next cycle of boom and bust impacts a new generation of students.
Isaac Bowers is a senior program manager in the Communications and Outreach unit, responsible for Equal Justice Works' educational debt relief initiatives. An expert on educational debt relief, Bowers conducts monthly webinars for a wide range of audiences; advises employers, law schools, and professional organizations; and works with Congress and the Department of Education on federal legislation and regulations. Prior to joining Equal Justice Works, he was a fellow at Shute, Mihaly & Weinberger LLP in San Francisco. He received his J.D. from New York University School of Law.