Report Suggests Reforms to Help Private Student Loan Borrowers

As fewer banks make private student loans, some borrowers are struggling to repay existing ones.

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Private student loans have a disproportionate effect on outstanding student loan debt because of their lack of borrower protections.

There has been some churn recently in the private student loan market. With JPMorgan Chase exiting the business – following Bank of America, Citigroup Inc. and U.S. Bank – Sallie Mae, Wells Fargo & Co. and Discover are left as the big three dominating the market.

But that's not the most important news for borrowers. Instead, the federal Consumer Financial Protection Bureau's efforts to provide new financing options for existing private loan borrowers, as described in its report "Student Loan Affordability," should take center stage.

All current students should strive to borrow only federal loans with their far superior protections. Graduate students can rely on PLUS Loans to ensure they only rely on federal loans to finance a graduate or professional education.

[Learn how the new student loan deal will affect borrowers.]

Unfortunately, federal loan limits sometimes force undergraduates whose parents cannot take out PLUS Loans onto the private market. Even more unfortunately –perhaps, as the bureau says, misled by the fact that private loans mimic federal loans – not all students take full advantage of the federal loan limits before turning to private loans.

From the Student Loan Ranger's point of view, the continuing decline in private lenders' share of the market that has been going on since the rise in stricter underwriting standards after the 2009 financial crisis is a good thing, even if it means some decline in competition that could lead to better terms for borrowers.

However, that decline is of little benefit to current holders of private student loans. There was about $150 billion in outstanding private student loan debt as of last year, according to a 2012 report by the bureau, and the cumulative defaults on these loans exceeded $8 billion on more than 850,000 distinct loans. That represents far too many struggling borrowers.

[Check out ways to graduate without student debt.]

Even worse, these borrowers have few good options: Despite a few helpful court decisions, most are unable to discharge their student loans in bankruptcy and, as a consequence, have little leverage when it comes to negotiating new repayment terms with private lenders.

As the bureau describes in its report from earlier this year, the potential impact of student debt burdens is huge. It may explain the increasing reluctance of young people to form new households, discourage the formation of new businesses by young entrepreneurs, decrease the retirement security of older Americans and result in fewer much-needed primary care physicians and teachers.

Of course, not all of these can be blamed on private student loans, which are, as already noted, a relatively small percentage of total outstanding student loan debt. But private student loans do have a disproportionate impact because of their aforementioned lack of borrower protections.

This particularly includes the lack of income-driven repayment options, such as the new Pay As You Earn plan for federal loans, which reduce borrowers' payments to an affordable percentage of their income.

The bureau's report outlines a number of options to make private student loans more affordable that should be considered by lawmakers.

The bureau first looks at options to allow borrowers to restructure private student loans, which could include requiring private lenders to offer repayment options similar to those offered for federal loans, amending repayment terms to make them affordable to borrowers based on a temporary or permanent debt-to-income ratio, or allowing borrowers to convert their private student loans to federal loans.

[Find out when to borrow through private student loans.]

The Student Loan Ranger supports the latter option, while recognizing that it could result in a windfall for some private lenders who originated very risky loans – and some of whom, such as for-profit colleges, anticipated high levels of default.

The second broad category of reform examined by the bureau is jumpstarting a refinance market. Student borrowers do not have a long credit history and so lending to them entails a large degree of uncertainty that is reflected in the generally high interest rates on private student loans.

Because of the lack of a refinance market, even borrowers who repay their loans on time while seeing their salary and equity increase, making them far less risky borrowers, cannot refinance their student loans at lower rates. This is in marked contrast to the housing market, for example, which has a robust refinancing industry.

While all of these reforms entail complications and trade-offs, they are eminently doable. The Student Loan Ranger feels the bureau's efforts to alleviate the unnecessary stress and suffering of far too many private student loan borrowers may also help improve the economic prospects of all of us.

Isaac Bowers is a senior program manager in the Communications and Outreach unit, responsible for Equal Justice Works's 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.