Unlike federal student loans, private student loans typically do not offer accommodations when borrowers are temporarily unable to repay — a key difference, according to Education Secretary Arne Duncan and CFPB director Richard Cordray, who spoke with reporters during a conference call Thursday ahead of the report's release.
"Federal student loans are the best deal around," Duncan said, saying borrowers benefit from features such as fixed interest rates and flexible terms when they return to school or suffer financial distress. Among his recommendations to Congress, Duncan urged it to push for similar flexibility in private student loans.
The report says current and former students, both graduates and nongraduates, owe about $150 billion to private lenders. Although the loans are just a fraction of the more than $1 trillion in total student outstanding loans, they represent a particularly troubled corner of the education-loan market, Duncan and Cordray said.
As the housing bubble ballooned, it was fueled in part by lenders' ability to make loans and then quickly resell them to so-called securitizers — Wall Street firms that packaged them as bonds — without retaining any of the risk. The report says the same thing happened in the market for private student loans.
One result was a steep rise in the volume of new loans, which quadrupled in seven years, from less than $5 billion in 2001 to more than $20 billion in 2008.
Another was a loosening of standards. For instance, the fraction of private loans made "without school involvement or certification of need" grew from 40 percent in 2005 to more than 70 percent in 2007, the report says. And it says lenders increasingly offered the loans to borrowers with lower credit scores.
The lenders also appear to have targeted borrowers at for-profit institutions. In 2008, 42 percent of undergraduates at those schools took out private student loans, compared with 14 percent of all undergraduates.
Duncan said that without the schools' involvement, students were less likely to realize that other, better financing options were available, such as the federal Pell Grant Program, which provides aid to qualifying low-income students, or fixed-rate federal Stafford loans. The report says 40 percent of private loan borrowers had not previously exhausted their eligibility for Stafford loans.
The difference can be costly. The report says the average rate among a sample of private lenders last year was about 7.8 percent. Although the most creditworthy borrowers could get rates in the range of 3 percent or 4 percent, better than a Perkins loan or an unsubsidized Stafford loan, variable rates on private loans rose as high as 19 percent.
Duncan said borrowing for college used to be the exception but has now become the rule — a trend driven by increases in higher-education expenses that have long outpaced increases in family earnings and other living costs. Credit obligations can hit former students hard, especially those who fail to complete degrees and cannot find work.
Among private-loan borrowers who started school in the 2003-04 academic year, the 2009 unemployment rate was 16 percent, the report says. And one in 10 recent graduates of four-year colleges have education-loan obligations — of all types — totaling more than a quarter of their monthly income.
Duncan said the consequences sometimes come as a shock. For many, he said, "The first time they ever really understood how much they owed was when the first bill arrived."
He urged prospective students to visit a new Education Department website, www.studentaid.gov, to help plan for costs. "Your job is to find the highest-quality education where you'll also get the best value," he said.
The lack of flexibility in private student loans can be especially tough on those in financial crisis.
Until 2005, when the finance industry persuaded Congress to toughen bankruptcy laws, private student loans were treated like other consumer loans when borrowers were unable to meet their obligations. The new law puts them in the same category as federal student loans — erasable in bankruptcy only in cases of "undue hardship," such as disability, said Henry J. Sommer, supervising attorney of Philadelphia's Consumer Bankruptcy Assistance Project.
Cordray repeatedly drew parallels to housing lenders' role in the 2008 crisis. "Before the financial crisis, some lenders in both markets engaged in aggressive marketing and risky underwriting," he said.
Like distressed homeowners, out-of-work student borrowers are stuck with few options, he said.
"Many borrowers told us their lenders were unable or unwilling to modify or adjust repayment terms even in these tough times," he said. "And the borrowers feel they have little leverage to negotiate reduced loan payments with their lenders."
Cordray said lenders had improved practices since 2008 — working with schools more closely, requiring cosigners, and discouraging students from borrowing more than they need. "Without investors willing to buy risky loans, lenders were forced to care more about a borrower's ability to repay," he said.
Contact Jeff Gelles at 215-854-2776 or jgelles@phillynews.com.
