March 3, 2008

Are Private Student Loans the Next Subprime Mortgages?

Private student loans are booming, and a consumer-advocacy group has taken a critical look at those nonfederal loans, which now account for nearly one-quarter of all education loans. The outlook: a feeling of “sad déjà vu” when compared to the subprime-mortgage industry.

In a report released today that outlined some of the dangers of private student loans, the National Consumer Law Center reviewed 28 private loans issued from 2001 to 2006. The group found all the loans to have variable rates, with initial annual percentage rates ranging from 5 percent to 19 percent. The average initial APR was 11.5 percent.

The survey also found an average origination fee of 4.5 percent (the highest origination fee for a loan in the study was 9.9 percent). Federal direct loans now have an origination fee of 2.5 percent.

The survey of the more than two dozen private loans found several other problems, the report says. A number of lenders in the study were unwilling to offer reasonable settlements, and some loans “stated explicitly that there will be no cancellation if the borrower or co-signer dies or becomes disabled.” Some went into default as soon as one payment was missed.

The report outlines many similarities between private student loans and subprime mortgages, including tightening credit lines, risk-based pricing, predatory terms, “push” marketing, and inadequate disclosures. The report states: “We cannot say with certainty that the student-loan market is headed for the same fate as the subprime-mortgage industry, but there are ominous signs.”

“As in the housing market, we are at this point because we allowed our government to outsource some of our most important social goals to the market,” the report concludes. “In many cases, the market works fine and provides the proper incentives to create profits and enhance social goods, but this isn’t always true. The market has been distorted due to investor interests that often conflict with the best interests of borrowers.” —JJ Hermes

Comments

1. If government was interested in taking care of the problem of ridiculous high interest rates, they could put a cap on all lending interest rates, including credit cards. Especially student loan rates. It is obscene for lenders to take advantage of students like this.

   — D. M. Kruger    Mar 3, 03:42 PM    #

2. What this article doesn’t mention is that all student loans, federal OR private, are not dischargable via bankruptcy. Combined with the fact that lenders are not regulated at all in the private loan marketplace, this is a recipe for disaster. Especially since, as anyone who watches television knows, the biggest trend in private student lending is direct to consumer loans. These loans, which require no certification by the school, can burden a student with debt far in excess of the cost of attending college. The Higher Ed act reauthorization is considering requiriing all student loans to be certified by a school, which should be a minimum standard. Hopefully, banking lobbyists won’t succeed in having this restriction pulled from the final law.

   — V Goldberg    Mar 3, 04:06 PM    #

3. Of course even with Stafford loans you can (and sometimes have to) borrow horrible amounts. Due to having cancer in grad school I have $116,000 in school loan debt (to be paid until I am dead of old age or close to it), $54,000 in medical debt due to crappy student health insurance with no cap on out of pocket and my PhD clearly is not worth this kind of debt load. Oh to have had a chrystal ball prior to entering grad school, I never would have done it.

   — annon    Mar 3, 04:11 PM    #

4. I think that the greedy banks screw themselves because what are they going to do if students don’t pay their loans? Beat it out of them? They cant repo your education, the only thing they can really do is try to garnish your wages but if they do that then how can you pay the government loans who come first in debtor line? Then can try to take your income tax return but what if you owe more? they’ll just have to take the loss! So ha ha ha aha greedy banks take that! I like this website i talks about predatory banks for future ref www.adviceontime.com

   — Jake    Mar 3, 04:27 PM    #

5. Increasing unsubsidized Stafford Loan limits or establishing an undergrad PLUS loan would shift private student loan volume to the federal loan programs. This would save students money and provide them with better loan terms at no cost to the government, so it could pass under PayGo rules. In fact, it would save the government money, since both the unsubsidized Stafford Loan and the PLUS loan have negative subsidy rates for both FFEL and DL according to the President’s FY2009 budget. The government would actually earn $500 million to $1 billion a year by raising the limits or establishing an Undergrad PLUS loan akin to the Grad PLUS loan.

   — Mark Kantrowitz    Mar 3, 04:48 PM    #

6. If Title IV loan limits were increased the need for private loans would decrease considerably.and students would be strapped with less debt. If institutions were held accountable for placing graduates then loans could be paid back from future earnings so let’s complete the loop and not just blame the existing system-it is fixable and not rocket science!

   — brad    Mar 3, 07:39 PM    #

7. We need to put our money where our mouth is – do we as a society put a value on higher education or not. It appears that we want to increase the gap between the haves and have nots. Strapping those who can least afford it with more loans is not the answer. We need to provide more grants programs. Private loans are a cancer to higher ed progragrams, but they will exist until we fix the student finance issues that currently exist.

   — Peggy    Mar 3, 09:46 PM    #

8. Its reading comments that start with “greedy banks” that simply befuddle me.

   Loans are a supply to a demand.

   Loans support education as long as grants/scholarships do not cover the cost of tuition, cost of education increases, and we as a country don’t save for our children’s education.

   At what point do we look to ourselves as a society and recognize if we are financially literate, this wouldn’t be an issue. If that was the case, those “greedy banks” wouldn’t be able to take advantage of the helpless, unassuming students.

   Spare me! What ever happened to personal responsibility?

   — Matt    Mar 3, 11:07 PM    #

9. Wow, we should definitely make public policy based on a survey of 28 loans-let me repeat that, 28 loans. This is a representative sample if I’ve ever seen one. We also don’t have any information on the sample itself. Usually, to be considered scientific, the author provides some basic information about the sample so that one can judge the fit to the population being measured. Strangely, that information is missing here.

   Perhaps I can be of assistance in this regard. I looked at a First Marblehead (one of larger private loan DTC lenders) securitization- 2007-1. Looks like the average borrower in this sample is paying 8.20% with today’s 3.11% one-month LIBOR rate (oh yes, there were 62,487 borrowers in this securitization). Gee, that’s lower than PLUS loans (of course PLUS loans are fixed rate). So I guess the implication is that 8.25% is “predatory”? It’s hard to figure out exactly what “predatory” means in the student lending context. Let’s use mortgage lending as a proxy. Apparently, the National Housing Institute defines predatory lending as “any unfair credit practice that harms the borrower or supports a credit system that promotes inequality and poverty.” Well, private lenders are providing a means to better oneself through higher lifetime earnings…so they’re not supporting “inequality and poverty”. I can’t get an 8.25% rate on my credit card today and I’ve been really good about paying my debt. That rate doesn’t seem “unfair” to me! So what’s really going on here?

   School certification for DTC loans, what a great idea! It’s really unfair to target private loan lenders for this “protection” isn’t it? If a student takes out a personal loan, or home equity loan, or borrows from a credit card to pay for their education do these have to be certified as well? Aren’t we interfering with the freedom to contract here (I’m not sure the Feds or the States can legally do this)? After all, if the borrower really needs a higher loan amount then the school will certify, he/she will most likely be driven to credit card debt to make up the difference. Is that what we want to promote with this “law”?

   — Patrick Bott    Mar 4, 12:59 AM    #

10. Patrick #9 thanks for point out the Emperor’s lack of clothes. This is politics, pure and simple.

    Most price inflation in colleges was caused by government throwing billions into system and higher ed inventing new “needs” for all that money. Do we really need anything more than the most rudimentary athletics? Do we need campus life offices? Do we need buildings to be torn down and rebuilt every generation? One of the losers in all this is the poor students who are excluded from schools or put themselves into life debt situations as Annon #3 posts above.

    — John    Mar 4, 07:01 AM    #

11. Are Private Student Loans the Next Subprime Mortgages?

    NEXT?

    I thought they already WERE.

    — kgotthardt    Mar 4, 07:17 AM    #

12. Here’s the thing about this study, and about private student loans in general.

    First, no one forces students to take these out – responsible lenders are even going so far as to warn students in advance of borrowing a private student loan, as are many financial aid officers.

    Second, this entire market exists solely because as a country, as a citizenry, we’ve decided other national priorities eclipse a willingness to spend tax dollars on education. For example, the estimated value of the Iraq conflict, using accrual accounting (as opposed to cash accounting, which only the government can legally use), is $3 trillion as of today. Each month spent engaged in operations runs $12 billion; in just 6 months, the same spending would eliminate not only private student loans, but all student loans, period, if we as voters chose to make it a national priority and elected a government in alignment with those priorities. We did not, we have not, and we have earned the system and priorities we currently have based on our choices.

    For reference on accounting, see Joseph Stiglitz’s new book, “The Trillion Dollar War: The True Cost of the Iraq Conflict”.

    — Christopher Penn    Mar 4, 07:26 AM    #

13. Amen #9…It’s about time someone stands up and speaks from the heart and facts, not the political garbage and the mud slinging major media puts out every day.

    One should ask himself why do we even have private loans. We have private loans because there is a need. Not because of “greedy banks” and “predatory lenders.” The facts will tell you both schools and students asked for these products because grants and scholarships were not keeping up with the increased costs year end and year out. And that is still the case.

    On another note. Stop comparing Direct Lending with Private Loans. And stop making synonymous FFELP loans with Private Loans. The author of this article needs to make sure they are comparing apples to apples. The author also needs to make sure they have the facts. Federal Direct Loans do not have an origination fee of 2.5%, the FFELP program currently has that. The Direct lending Program has Origination Fees of up to 4%. The FFELP loan program is governed by the feds, private loans are not.

    — ta    Mar 4, 08:23 AM    #

14. I think Congress should repeal Sect. 568 of the Improving America’s School Act of 1994 which allows colleges to set price based on “need.” This form of price discrimination allows schools to price the same good to different consumers and avoid regulation under the antitrust laws of this country. The GOA did a study in Sept. 2006 that really did not provide too many good reasons for this exemption and it also “sampled” 28 colleges. In fact over a 5 year period of time, tuition increased 13%, but “aid” only increased 7%. I think the whole “need based” system needs to be overhauled and if Congress wants to give tax breaks to promote diversity, it can increase taxes by 10% of income which is basically what Harvard is accomplishing, but then everyone would know the price berforehand. If Harvard wants to “tax” people at 10% of their gross earnings to pay for college, why stop at 180k? Isn’t that the job of Congress? And who audits these colleges to ensure that they are taxing appropriately? Isn’t that the job of the IRS? Everybody can agree that housing is a significant “right”, but yet we do not set price based on 10% of our income. Everybody knows the price of a house and the same should be true about education. That way the borrowers who are suppose to act responsibility will have the tools to do so. In addition, without the market inefficiency of price discrimination, price will go down and the borrowers will not need to take out as many loans and run the risk of unsustainable debt.

    — DL    Mar 4, 08:57 AM    #

15. #14 – What do you mean ‘set price based on need.’ Are you referring to the amount the student pays – which is cost less grant financial aid? For federal grant aid, the colleges don’t set the eligibility requirements. For institutional aid, the school does establish awarding policies for merit and need based aid. None of this is governed by federal requirements. State legislators set the tuition and other costs for pubic institutions. Boards of Trustees approve these costs at private non profit colleges. What are you referring to?

    — Dr. Pat    Mar 4, 09:16 AM    #

16. #13- The writer of comment 13 needs to recheck their facts. Direct lending origination fee for subsidized and unsubsidized loans is actually being reduced for the 08-09 academic year. It is reducing from 2.5% to 2.0%. It is the DIRECT PLUS loan origination fee that is 4% and is not changing. All of these loans also get a 1.5% interest rebate. I wonder if the writer of comment 13 is a financial aid professional? If so, I would suggest that they go out to ifap and read the direct loan bulletin that posted on Feb 29 stating these facts.

    — J    Mar 4, 09:23 AM    #

17. #16 I stand corrected.

    I am a financial aid professional, however, I used a different source for my information. See link below.

    http://www.ed.gov/offices/OSFAP/DirectLoan/faq.html

    Frequently asked questions #7.

    Thanks for bringing it to my attention.

    — ta    Mar 4, 03:46 PM    #

18. This is, of course, a bigger and more complex issue than can be described here. Why hasn’t anyone pointed out that the reason students need these loans is because the COST of education is increasing faster than the rate of inflation? If the costs of attending were lower, then there would be less borrowing. Students who borrow federal loans are limited to $7500 (in whatever combination sub and unsub) for their first year. With many private schools costing well over that for just a year how are students supposed to pay the difference? If a student is dependent he/she can only get $3500 and then a parent needs to apply for a loan to bridge the gap. Only when the parent is denied a PLUS can the student take out the remaining $4000. That is what lead to private loans. The necessity to bridge the gap and make a college education within the reach of someone who can’t pay the difference in cash. Also someone could argue that the cost of education is going up because it is more expensive to give today’s students (the ME or I generation) what they are demanding…high speed internet access, an e-mail alert when their laundry is done, cappuccino bars in the student union open 24 hours, suite-like accommodations in the dorm room, etc….. Or you could argue that now that college is becoming the norm for students after highschool that the cost is going up to try to make college more elite and harder to reach, to try to add value back to a degree. For institutions that regard themselves as more elite to begin with they may try to maintain their elite and exclusive status by continuing to increase their costs to amounts that are hard to borrow in an age where it is so easy to obtain a loan (though as of late becoming increasingly difficult) to pay for 30 or 40 thousand dollars a year in education expenses. Also, why would a student try to attend a costly school when there are so many options out there that cost much less like community colleges or public state schools? If they want/see a need to go somewhere that forces them to take out large loans and they do, then who is to blame? Now there is much finger pointing at the federal government for not regulating this but if someone chooses to take out loans that are more than they can afford, is it really the fault of the government? Or was the government allowing someone the opportunity to try to get the education they wanted or thought the deserved? I don’t think there is any one person or thing that can be “blamed”. Now the US is in a crisis because so many people took out too much in education loans, bought more house than they could afford…etc. Sounds to me like we could use more educating BEFORE we are able to make poor decisions that have significant impact. What scares me now is that these people who are unable to make good decisions with significant amounts of their own money are going to be the ones who are voting.

    — Layer Cake    Mar 4, 05:40 PM    #

19. While I am unsure about whether private loans amount to sub-prime loans. I recently finished an article looking at the loan industry and bankruptcy (see Notre Dame’s Journal of College and University Law). I think both sides have valid points of the negatives and positives of private loans. But, I ask a simple question. When I borrow my current loans for law school, I am paying interest rates of 7 to 8.25% for the life of the loan. My loan on my house that I am about to close on is 5.825%. If student loans are there to make higher education more accessible, why is it cheaper to borrow money for a house than it is to pay for eduction?

    — C. Aaron LeMay    Mar 5, 10:15 AM    #

20. #19-the answer is simple, the mortgage lender can take your house if you default. There is no house or other asset standing behind a private credit loan. Therefore, the mortgage lender will definitely recover a large portion of the loan by seizing and selling your house if you default, whereas the private lender has no asset to seize to mitigate the losses from default on the private loan. That’s why it costs more to borrow a private education loan relative to a mortgage loan. Private loans are unsecured credit-the severity of the losses is greater for the lender.

    — Patrick Bott    Mar 5, 12:52 PM    #

21. Mr Botts, quit trolling boards under the pretense of being an “avg joe” interested in personal responsiblity… You have a vested agenda from what it appears as you are the Director of a financial Services Agency that specializes in serving student loans and offering private loan products…
    http://www.campuspartners.com
    You also have a linked in Profile listing this information as well.
    http://www.linkedin.com/pub/4/2B1/049
    How would your PR department feel about you shooting your mouth of all over the place on boards and whatnot? People… be skeptical of the hardliners on BOTH sides of the battle… usually you find lobbyists or industry insiders.

    — Sick of Mr. Botts    Mar 5, 02:02 PM    #

22. In response to Mr. Botts #20, I agree that the difference between the loans is one is collateralized and one is not. However, mortgages can be discharged through bankruptcy or foreclosure meaning you lose the house in this instance. Therefore, the costs of those loans can be even more expensive than student loans of any type in the event the bank exercises a foreclosure on the house. Student loans of any type are not dischargeable therefore the banks have an almost guarantee of continual revenue from those loans. In the event of bankruptcy, the borrower has a very difficult standard of undue hardship to meet for discharge. So, I think have oversimplified the answer and not taken into account all circumstances of the loans.

    — C. Aaron LeMay    Mar 5, 04:03 PM    #

23. Also, in response to Mr. Botts #20, I am not your push over, unknowledgable responder. You may want to check out that article mentioned in my 1st comment. It could be a sign of things to come for your business.

    — C. Aaron LeMay    Mar 5, 04:11 PM    #

24. That’s really clever “Sick of Mr. Botts”. I guess cheap attempts to intimidate me and otherwise discredit my posts are the best you can muster in this discussion. I’ve never claimed to be anyone else other than Patrick Bott there “Sick of Mr. Botts”. I’m exercising my rights of free speech as an American. I have the courage of my convictions, and I’m not a coward. Can we say the same thing about you “Sick of Mr. Botts”?

    C. Aaron LeMay, my name is Patrick Bott.

    — Patrick Bott    Mar 5, 06:12 PM    #

25. Mr. Bott, I looked at the First Marblehead 2007-01 securitization (from www.sec.gov, “National Collegiate Student Loan Trust—2007-01, Form 424B5 (Prospectus)) and you are correct that the rate is LIBOR plus 5.09%, but when has LIBOR been as low as 3.11% before and for how long? Isn’t LIBOR historically at 5% which would make these more like 10% loans? You also did not mention that “TERI charges a guaranty fee for each loan it guarantees,” which I believe would increase the cost of the loan by around 9% in addition to the interest rate. These loans are not like credit cards because the average term is more than 20 years. These loans are also not like mortgages because no mortgage has a 9% loan origination fee in addition to interest. These loans are not like auto loans because an auto loan is generally 3-5 years versus 20 years. Consumers (co-signors) should ask why they would make payments for 20 years for attending classes for 4 years. The answer, and in answer to Dr. Pat, may be in the “push market” described in the study the Chronicle of Higher Education was reporting and the subject of this discussion. First Marblehead describes the objective of GATE Education Loan Program as one that “helps your school attract and enroll students that fit your profile—while controlling your tuition discount and keeping revenue high.” First Marblehead thus enables schools to price discriminate by providing the financing to do so. Professor Richard Vedder in Chapter 4 of his book, “Going Broke By Degree—Why College Costs Too Much” explains price discrimination in the form of tuition discounting much better than I could, but that was the gist of my point regarding why colleges should not be exempt from the anti-trust laws that govern any other good, service, or industry.

    — DL    Mar 5, 10:38 PM    #

26. Mr. Bott I am going to follow the assumption that you represent Campus Partners in your threads from now on. I think it is HIGHLY unethical to not disclose this before disseminating such strong points of views. Just as a borrower has a perspective. so do you as someone with a vested financial interest in the industry as an employee and/or affiliate of Campus Partners. I have no vested interest other than being a borrower and citizen, the tide runs deeper with you, and like I said, I am following the assumption that all opinions you express represent those of Campus Partners and their affiliates.
    For those of you who are interested, Campus Partners website is
    http://www.campuspartners.com

    — Sick of Mr. Bott    Mar 6, 03:42 AM    #

27. I would just like to comment that these post have probably been some of the most educational and informing that I have ever read on the Chronicle. I would just like to say thank you to everyone who contributed. I wish there would be more discussion along these lines. As a student in graduate school, and having had a full scholarship in undergrad, I never had to worry about loans and such. This was a huge wake up call for me and I think that this problem has a lot of different parties who are to blame; the government, banks, private loan agencies, universities, and consumers all affect this situation.

    — Marjorie D    Mar 6, 10:47 AM    #

28. Sorry to disappoint “Sick of Mr. Botts” or “Sick of Mr. Bott” whoever you are! The opinions and views I express and have expressed are my own. Always have been, always will be. They are not the opinions and views of my current employer, past employer, or any prospective employer.

    — Patrick Bott    Mar 6, 08:39 PM    #

29. Well Mr. Bott,
    How about you simply discose that you are the director of capital markets for an organization involved in the student lending agency from now on, then we will know! Arguably, you have a VESTED interest just as a borrower does.

    — Sick of Mr. Bott    Mar 8, 10:55 AM    #

30. I love being lectured on ethics by somebody who is incapable of affixing his or her name to his or her post. You’ve also gone from speaking about borrower in the first person to borrower in the third person. My guess is, you aren’t the citizen borrower you originally described yourself as! Perhaps you are a lawyer? Maybe one of the lawyers who crafted the report I’ve commented on? And instead of refuting the merits of my comments (note: my comments) made with regard to the obvious holes in the report, you choose to personally attack me “Sick of Mr. Bott” or “Sick of Mr. Botts”. We should all be as ethical as you. I’ve told you everything you need to know about me. You’ve told nothing and everything at the same time! Have a nice life “Sick of Mr. Bott” / “Sick of Mr. Botts”!

    — Patrick Bott    Mar 8, 02:07 PM    #

31. What this article doesn’t mention is that all student loans, federal OR private, are not dischargable via bankruptcy.

    I think the first time this is tested in court it will be found to be unConstitutional. Banks and Mortgage companies try to get you to sign documents which are not enforceable and Constitutional. If ENRON can declare bankruptcy and get out of its commitments, then students who have been hoodwinked by unscrupulous student loan officers can walk away, declare bankruptcy and take jobs offshore. If the jobs are being outsourced, then there is no reason for the students to not declare bankruptcy and move offshore just like the many American companies which have done so. I pity the poor banks and mortgage houses which will be left holding the worthless loan papers, But then what about all those holding Enron stock. It will be justice if the banks and mortgage houses take the hit this time, as they have hoodwinked a lot of our young people, who should just default in large numbers, declare bankruptcy and file class actions law suits for protection. The American taxpayers and parents will stand strong behind our young people who have been hoodwinked by the unscrupulous student loan officers. Just declare bankruptcy and let the banks and loan officers come after you. What they have done is unConstitutional and their predatory contracts will not hold up in court. Again, the students have the same rights to declare bankruptcy as Enron and the corporations. Do not be hoodwinked, Fight for your right to declare bankruptcy just like Enron did. Their executives were able to keep their bonus, … Just return your books and lecture notes to the banks and loan companies. They hoodwinked you and now they need to pay the price by eating the loans.

    — Karl    Mar 9, 01:49 PM    #

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