Private student loan report: Is subprime mortgage crisis comparison fair?

A new government report says the private student loan market suffers from risky terms and lax underwriting, paralleling the subprime mortgage debacle.  Private lenders say the criticism is out of date.

A new government report casts the private student loan market in the past decade as parallel in many ways to the subprime mortgage debacle – rife with risky terms, lax underwriting, and aggressive direct marketing to borrowers who often didn’t fully understand their options.

“Our findings reveal that students were yet another group of consumers that were hurt by the boom and bust of the financial crisis,” said Richard Cordray, director of the year-old federal Consumer Financial Protection Bureau (CFPB), which issued Friday’s report in conjunction with the US Department of Education.

The report is prompting renewed calls for tighter regulation of private student loans and a stronger safety net for borrowers – including bankruptcy options. But representatives of private lenders say that the share of student loans they issue has dramatically declined, and that regulations and voluntary practices in recent years provide sufficient protection.

Among the report’s findings:

• The private student loan market grew from less than $5 billion in 2001 to more than $20 billion at the peak in 2008, then rapidly contracted during the financial crisis.
• Some lenders bypassed school financial aid offices, marketing directly to students, and often lowering the minimum credit score required. There was little incentive to ensure the loans could be paid back, the report suggests, because lenders made their money up front by bundling and selling loans.
• Many students did not understand or take advantage of their eligibility for less risky federal loans before taking out private loans.
• Most private loans have few options for payment modification or forbearance.
• More than 850,000 private student loans are in default, representing $8.1 billion. Since 2005, discharging private loans in bankruptcy has been nearly impossible.

“The report is a call to action to protect students and families from risky private loans, provide relief for those who are now trapped because of reckless and deceptive private lending, and encourage the use of safer federal loans,” said Lauren Asher, president of The Institute for College Access & Success, in a statement.

Casting private lenders in a negative light with the use of terms like “subprime” isn’t necessarily fair, given that the federal government, which makes a far larger volume of student loans, also lent to most of the same borrowers who turned to private loans, says Jason Delisle, director of the Federal Education Budget Project at the New America Foundation in Washington.

Students, by definition, often have low credit scores or no credit history. “Does that mean the federal government is a subprime lender? Policymakers should be careful in how we characterize this [issue] because [it could] undermine support for the federal student loan program,” Mr. Delisle says.

Some students with federal loans do have the option to defer payments or lower them if they are unemployed or have low incomes. But neither federal nor private education loans can be discharged in bankruptcy, Delisle says.

One recommendation of the report is for lawmakers to consider how borrowers might be able to restructure their debt through the bankruptcy process.

The report acknowledges that many of the trends and problems it describes have changed since the financial crisis hit in the wider economy. Lending standards have changed, for instance, so that lenders can’t as easily sell off the loans they make to students. 

In 2011, 90 percent of private student loans had a creditworthy co-signer, up from 67 percent in 2008.

More than 90 percent of private loans are now reviewed by a school financial aid office to make sure that the aid matches the need. In 2008, just under 30 percent of the undergraduate loans were school certified.

One of the biggest sources of confusion for borrowers was that many lenders used to offer both federal and private loans. That ended in July 2010 when all new federal loans began being issued solely by the federal government.

“The Obama administration deserves a lot of credit [for that change]…. That’s already solved a big part of the problem,” Delisle says.

Given current practices and regulations, private lenders “are quite concerned by the unfair implications … that this segment of the consumer lending market ‘operates in the shadows,’” wrote Tom Deutsch, executive director of the New York-based American Securitization Forum (ASF), in a letter to the CFPB in January. ASF members include, among others, groups that issue, service, and invest in private student loans.

To help student borrowers and their families, the Education Department and CFPB announced Friday a new online tool called the Student Loan Debt Collection Assistant. 

For borrowers who are not yet in default, it can help them find alternative payment plans and avoid burdensome fees. For those already in default on federal student loans, it shows how to access special repayment options. And for those with private loans, it offers tips on how to negotiate with debt collectors.

 “We still have some work to do to ensure that students who take out private student loans have the same kinds of protections offered by federal loans,” said Education Secretary Arne Duncan in a statement Friday. “In the meantime, if you have to take out a loan to pay for college, federal student aid should be your first option.”