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The Private Student Loan Racket

http://education.newamerica.net/publications/articles/2009/the_subprime_student_loan_racket_13756

Highlights:

At around 2000, college tuition was skyrocketing–a trend that has only accelerated–and federal grants and loans weren’t keeping pace. To fill the gap, financial aid officers started cutting deals with lenders to bring in private loan money. In the case of proprietary colleges, most of the large publicly traded chains forged arrangements with Sallie Mae, the nation’s largest student loan company. (Once a quasi-government agency like Fannie Mae, it became entirely private in 2004.) In exchange for pots of private student loan funds that they could dole out at will–meaning without regard for students’ ability to repay the debt-the schools gave Sallie Mae the right to be the exclusive provider of federal student loans on their campuses. Lenders vie fiercely for this privilege because federal loans are guaranteed by the government, meaning the Treasury pays back nearly all the money if the borrower defaults. Thus lenders get to pocket generous fees and interest and bear almost no risk.

Sallie Mae clearly understood that these private loans were going mostly to subprime borrowers who might not be able to pay them back; in 2007, Senate investigators uncovered internal company documents showing that executives expected a staggering 70 percent of its private student loans at one for-profit school to end in default. Investigators concluded that Sallie Mae viewed these loans as a “marketing expense”-a token sum to be paid in exchange for the chance to gorge on federal funds.

The frenzy only intensified after Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005. This made it almost impossible for those who took out private student loans to discharge them in bankruptcy and, not surprisingly, turned the private student loan market into a much more appealing target for lenders.

As a result of these changes, private loan borrowing has skyrocketed. In the last decade alone, it has grown an astounding 674 percent at colleges overall, when adjusted for inflation. The growth has been most dramatic at for-profit colleges, where the percentage of students taking out private loans jumped from 16 percent to 43 percent between 2004 and 2008, according to Department of Education data.

The spike in private loan borrowing is dismal news for students. Unlike traditional student loans, which have low, fixed interest rates, private educational loans generally have uncapped variable rates that can climb as high as 20 percent–on par with the most predatory credit cards. Private loans also come with much less flexible repayment options. Borrowers can’t defer payments if they suffer economic hardship, for instance, and the size of their payment is not tied to income, as it sometimes is in the federal program. Private loans also lack basic consumer protections available to federal loan borrowers. With a traditional federal student loan, for example, if a borrower dies or becomes permanently disabled, the debt is forgiven, meaning they or their kin are no longer responsible for paying it off. The same goes if the school unexpectedly shuts down before a student graduates. But none of this is true of private loans. Also, because it is so difficult to discharge private student loans in bankruptcy, when students take them out to attend schools that provide no meaningful training or skills they can find themselves trapped in a spiral of debt that they have little prospect of escaping.

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