Private Loans

The Obama Administration is moving forward in defining what it means for career education programs to “prepare students for gainful employment in a recognized occupation.” This requirement – which applies to programs at public, nonprofit, and for-profit colleges – has long been in federal law, but, without a rule defining what it means, the Department has been powerless to enforce it.

The draft rule would measure career education programs’ outcomes in two ways. First, the debt burdens of program graduates who received federal aid would be compared to their later earnings. Second, students’ ability to repay their loans – including both graduates and noncompleters – would be measured through a program-level cohort default rate.  Programs where graduates’ earnings don’t justify typical levels of debt, and those where borrowers too frequently default on their loans, would lose eligibility for further federal grants and loans unless the programs improve.

The data released by the Department in conjunction with its proposed rule are alarming. They couldn't make a better case for why the rule is desperately needed and must be strengthened to provide meaningful protections for students and taxpayers.

To illustrate:  Of the 4,420 programs in the dataset with complete data (meaning that both students’ debt burdens and default rates are calculated), there are 114 programs where the data show more defaulters than graduates.  In other words, students receiving federal aid to attend these programs are more likely to find themselves unable to repay their debt than they are to complete the credential they sought.  It’s also important to understand that this very much understates the problem at these programs.  That’s because, due to the way that debt burden and defaults are measured, these figures represent the defaults from one cohort year (those who entered repayment in 2009) compared to two years’ worth of completers (those who completed in either 2008 or 2009).

Here are a few facts about these 114 programs with more defaulters than graduates:

  • All 114 are at for-profit colleges, and most (82) are associate degree (AA) programs.
  • They include a sizable share of measurable programs in some fields. Seven of the 13 AA programs in ‘securities services administration/management’ have more defaulters than graduates.  Six of the 17 ‘accounting technology/technician and bookkeeping’ AA programs have more defaulters than graduates.  And the same is true for all three of the AA programs in ‘criminalistics and criminal science.’
  • Almost two dozen of them (23 of the 114) fully pass the proposed rule’s modest standards. Of the others, 14 are “in the zone” – a program limbo for those not good enough to pass and not bad enough to fail outright – and 77 fail.

The fact that 20% of the programs leaving more students in default than with credentials pass the Department’s proposed tests clearly shows that the tests aren’t strong enough. And even the 68% of programs that fail outright would remain eligible for federal funding under the proposed rule unless they failed again. What is also crystal clear from the data is that the stakes for students are high:

  • Many of the programs are huge: 33 of the 114 programs had more than 1,000 students who entered repayment in a single year, and 6 of them had more than 5,000 borrowers who entered repayment in that year.
  • There are seven programs where the number of defaulters exceeded the number of completers by more than 1,000.  All seven are at the University of Phoenix.

These are parasitic programs, consuming resources to the detriment of students and taxpayers. Reasonable people may disagree on certain aspects of the Department’s proposal, but the need to strengthen the rule so programs like these must shape up should not be one of them. Click here for a sortable list of the 114 programs with more defaulters in one year than graduate over two years. To read the New York Times editorial on our May blog post, click here. - Debbie Cochrane

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The Project on Student Debt has released Private Loans: Facts and Trends, using data from the U.S. Department of Education’s National Postsecondary Student Aid Study (NPSAS), a comprehensive nationwide survey conducted every four years. Our analysis from 2007-08 reveals that two-thirds of private loan borrowers did not take out all they could in safer, more affordable federal loans. The fact sheet also found that a majority of private loan borrowers in 2008 attended schools with tuition and fees of $10,000 or less, and that African-American students were the most likely to take out private student loans.

Like credit cards, private loans usually have variable interest rates that are higher for those least able afford them – as high as 18 percent in 2008. But unlike credit card debt, private loans are nearly impossible to discharge in bankruptcy. They also lack important consumer protections that come with federal student loans. Private loan borrowing has slowed since the credit crunch, but these risky loans remain available from major lenders.

Among the findings:

  • While experts agree that private loans should be used only as a last resort, the share of private loan borrowers who could have borrowed more in federal Stafford loans increased dramatically, from 48 percent in 2003-04 to 64 percent in 2007-08.
  • Private loan borrowing is not limited to students at high-priced schools. In fact, the majority of private loan borrowers (63 percent) attend colleges with tuition and fees of less than $10,000.
  • Among all racial and ethnic groups, African Americans are now the most likely to borrow private student loans. The percentage of African-American undergraduates who took out private loans quadrupled between 2003-04 and 2007-08, from four percent to 17 percent.

For more information about private loans, please visit Private Student Loan Publications and Resources

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By Lauren Asher, Vice President

In Monday's New York Times article about a new state student loan program for New York, a spokesperson for Governor Paterson's budget office said, "One of the big problems in the student loan program is that it is drying up. People who were able to get loans last year can’t get them this year." This kind of misleading statement encourages students and parents – already rattled about how to pay for college – to believe they’ll have trouble getting the most common and affordable type of student loan: a federal loan. In fact, federal student loans remain fully available to all eligible students and parents.

The New York program will encourage undergraduates to borrow up to a stunning $50,000 in state loans, even though dependent undergraduates can already borrow up to a total $31,000 in federal Stafford loans. These federal loans have lower interest rates than the New York loans and come with significant borrower protections and guaranteed access to affordable repayment options.

While it is true that the availability of private student loans has declined due to changes in the broader financial markets, only 8% of the undergraduate class of 2007 used private loans, and an estimated 40% of them had not maximized their federal borrowing options first.

If the goal of the new loan program is to make college more affordable, it misses the mark. Nationally, more than two-thirds of students who graduate from four-year colleges already carry an average of about $22,000 in student loan debt – with similar numbers for New York state. Struggling students should not be burdened with more debt, which will leave them even less able to buy a home, support a family, or save for retirement when the economy picks up again. Instead, tough economic times require states and the federal government to invest in higher education in ways that reduce the need to borrow.

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Lenders have made it clear that students with poor credit are less likely to be able to find a private student loan. Fortunately, students have good federal options. But for students or parents with good credit who decide they want a private student loan, have rates increased? Some analysts guess yes, but it is a difficult question to analyze. Unless lenders release their pricing policies (which they don't), the only way to find out if rates have, indeed, gone up is to get old and new quotes for the same person with the same qualifications for the same type of loan. We now have two such tests, me and a colleague. My colleague got quotes from seven lenders two years ago. This month she applied again to those same lenders. The results: four offered her a lower rate than two years ago, one offered a higher rate, one rejected her, and one had suspended operations. Combined with my results, this very small sample suggests that rates are unchanged or even down for people with good credit. There’s another way to look at this, though: What was the lowest rate my colleague found two years ago compared to the lowest offer now? By that analysis, she would pay a rate one-tenth of a percentage point higher now than two years ago. (That’s because the one rate that had gone up was the one that was the lowest before). An increase, but a very small one. Here are the details of my colleague’s loan offers. Two years ago (April 2006) My Rich Uncle offered her a rate of LIBOR plus 2.65 percentage points; now (March 2008) the rate is LIBOR plus 4.0, an increase of 1.35. In contrast, Access Group offered her the lowest rate this time around (LIBOR plus 2.75), a full 1.2 percentage points lower than that company’s offer two years ago. The rates from Bank of America, Sallie Mae, and Citibank had all dropped by one to two tenths of a percent. Education Finance Partners mysteriously denied her a loan this time, suggesting a co-borrower, while Loan to Learn has shut down its operations.

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Nearly a year ago, long before the current credit crunch, I spent some time reviewing the various methods of comparing prices on private student loans. I found that the "as low as" rates advertised on comparison sites don't tell the shopper very much. I also found that it is very difficult to get an actual rate quote for comparison purposes, because you have to complete entire applications, turn over personal details, and authorize credit checks. And those multiple credit checks from potential lenders can have the effect of hurting your credit score, because they create the impression that you are desperate to get a loan. Nonetheless, I persevered and got some actual interest rate and fee quotes, and the promissory notes to go along with them. With all the doomsday stories about the credit crunch, we decided it was time to see if we could confirm that even someone with good credit (still me, despite tempting fate with all those loan applications) would have a tougher time getting a loan or would face higher charges. So last week I went back to two of the lenders who had offered me loans last year, National City and Suntrust. I plugged in the same loan amount, degree program, and other details. Their responses seemed to take a day or two longer than last year, which may be a result of some of the layoffs in the industry. But both of them got back to me with rate quotes and promissory notes. The rate at National City was higher than last year, by the equivalent of about half of one percentage point (0.25 higher interest rate, 3.5% higher fee, 20-year term). But the rate at Suntrust was exactly the same as last year: the one-month LIBOR index plus 2.5 percentage points, with no fee. Now I'll see if I've ruined my credit rating by applying for these loans. Then I'll be able to test whether someone with bad credit can get a private loan. (Fortunately, even if my credit has been destroyed, I can always get Federal Stafford Loans because they require no credit check).

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In our testimony to the Iowa legislature's Government Oversight Committee yesterday, we recommended that the state seek details on the rates charged to students by the Iowa Student Loan Liquidity Corporation, the nonprofit lender created by the state. Mark Kantrowitz, publisher of FinAid.org, agrees with us and suggests additional information that should be disclosed by lenders. He also dismisses nonprofits' claims that rate information should be kept secret:

"Ideally, I'd like to see lenders disclose the mappings from credit scores to their rate tiers and not just the tiers themselves. Add a FICO Score Range column to your table. The lenders insist that they cannot or will not do this voluntarily because it reveals competitive information. But it's really all about obscuring the mapping from borrower characteristics to rates. Yes, if lenders had to publish their tiering, there'd be more competition. But isn't that the point? If lender X knows that lender Y's cutoff for LIBOR + 2.0% is FICO 750, lender X can potentially undercut with LIBOR + 1.8% at FICO 760. By making the mapping opaque, they minimize the opportunity for competition. But, frankly, it also probably has a lot to do with making it harder for borrowers to shop around by forcing them to apply to obtain rate information. Lenders don't want clear information because student loans are a commodity, and if they let it behave like one, supply and demand will drive down prices." "It's especially egregious when a state agency protests against releasing detailed pricing models for competitive reasons. What they're saying is that if they release the data, their competitors will be able to undercut them on price. Why is that a problem? Either it will force ISLLC to cut prices, or their borrowers will go elsewhere to get lower prices. Either way ISLLC's mission to enable students to pay for college is met. Of course, more likely ISLLC is not adequately aligning pricing with cost, profiting from some students to subsidize others, and so will be prone to price competition on them. But the real problem is you have agencies thinking about profits first and public benefit second."

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By Deborah Frankle, Research Analyst Private or alternative loans comprise a growing share of student loans, despite being more costly than federal student loans. Students and parents are often unaware of the differences between private and federal loans, and many borrowers don’t know which they have until they enter repayment. Unfortunately, despite required informational sessions about federal loans, the majority of college financial aid offices are not doing much to educate students about private loans. The National Association of Financial Aid Administrators (NASFAA) recently conducted a survey of how financial aid offices discuss alternative loans with their students, results of which can be found in their magazine, Student Aid Transcript. The survey results showed that 63% of financial aid offices do not address alternative loans at all during entrance and exit counseling, the information sessions required when federal loans are taken out and again when the student leaves school. And while 58% of financial aid offices do provide more information about financial planning and debt management than they are required to, only 25% offer in-depth counseling on alternative loans specifically. Barnard College recently became part of this minority by requiring students or parents who apply for a private loan to talk with the financial aid office before Barnard will certify a students' enrollment (and access to the loan). The goal of these conversations was not to discourage people from taking out private loans, but just to be sure that they understood the differences, cost, and potential consequences involved. Still, this simple policy change reduced alternative loan volume by 73% in one year. The college found that many who initially wanted an alternative loan were not aware of the associated risks and interest rates, and had not fully considered other viable options. Such a huge drop in private loan volume suggests that the students who were initially drawn to these loans might not have really needed them. Preventing unnecessary and risky borrowing is good for students, and should be a goal of all financial aid counselors. If the drop in alternative loan volume experienced by Barnard College is anything near the potential alternative loan decreases possible at other colleges, the 73 of college financial aid offices that do not currently guide students through these decisions should consider doing so.

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It is easy for consumers to forget just how expensive a few percentage points of interest really is. I made this point on Tuesday in my presentation at the annual conference of the National Association of Student Financial Aid Administrators. Assume you have $10,000 in loans and the interest is deferred for four years of study, and then the loan is paid in equal installments over ten years:

  • For a subsidized Stafford loan (on which the government covers interest during deferment), the total interest you would pay during that 14-year period would be $3,810.
  • For an "unsubsidized" Stafford loan, the 6.8% interest yields total interest payments of $7,967.
  • If you have a private loan with an interest rate of 10%, you would pay $13,085 in interest on top of that $10,000 borrowed.
  • At 12%, the cost increases by more than $4,000, to $17,091 of interest.
  • At 14%, add another $4,000, to $21,469 of interest.
  • At 18%, you pay a whopping $31,921 of interest on top of the initial $10,000 borrowed, more than four times the interest on an "unsubsidized" Stafford loan.

These numbers, and the differences between them, would of course be even larger if you extend repayment beyond the 10 years used in this example. In an uncertain economy, these examples tell you just how valuable that fixed 6.8% maximum interest rate is on federal student loans (and a maximum of 8.5% on parent loans), whether they carry the "subsidized" moniker or not. If the numbers alone are not enough to convince, there are many other benefits to federal loans. In a NASFAA session I recently attended, Martha Johnston of Citizens Bank provided a helpful list, including:

  • Federal loans carry automatic full insurance in cases of death or disability. It's not something parents like to think about, but it happens.
  • Home equity loans (which may carry an interest rate that rivals the federal rate) put your home at risk.
  • Federal loans have unemployment and economic hardship deferments, as well as up to 60 months of forbearance.
  • No prepayment penalties on federal loans, and some ability to extend repayment without a change in the interest rate.
  • The interest rate on federal loans doesn't go up when rates in the economy increase. (Though it also doesn't go down if rates were to drop).

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Public confidence in college financial aid offices has been shattered by revelations of gifts, trips, deals, and kickbacks from lenders. In the resulting confusion, I have been asked time and again: "Is there a web site you can recommend where students can get accurate, complete and unbiased comparisons of student loan rates?" Unfortunately, the answer is no. The sites we have seen take money from lenders in exchange for getting listed. Often, lenders pay a premium to get prominent placement in the user’s search results. In some cases, "comparison" sites actually lead to only one or two lenders out of the thousands in the market. Even on sites that feature multiple lenders, it is perilously easy to be led down the wrong road, ending up with higher-cost loans that do not carry the interest caps and other protections that come with federal loans. I recently logged into SimpleTuition.com to see what loan offers I could get if I decided to pursue my MBA at U.C. Berkeley. The lowest rate on the list (showing up on page 2) was 7.27% for a private loan from a company called Student Funding Group LLC. The price-conscious and time-constrained consumer, having found the best deal, might click on the "apply now" button and end the comparison shopping. Instead, I opened the expanded version of the search results, which revealed that the 7.27% is the "as low as" rate. It’s not a sure thing until I submit a complete application and allow the lender to peruse my credit reports. Still, I had reason to be optimistic. MyFICO.com said my credit is so good that "Most lenders will consider offering you their most attractive and most competitive rates" and may even offer me "special incentives and rewards targeted to their 'best' customers." I should be a slam-dunk for that as-low-as rate of 7.27%, I thought. I proceeded through the application process (no, it didn’t take only a minute, as advertised) and eventually got a rate quote: 8.75% plus 4% in fees, or the equivalent of between 9 to 10% -- much more than the 7.27% that at first appeared possible. Many (maybe most) consumers, after filling out that whole application, would go ahead and take the loan even at the higher rate, assuming there was some good reason they can’t get the as-low-as rate. But I decided to compare. A second lender, Sun Trust, had showed up on SimpleTuition with an as-low-as rate of 7.28%. After submitting, again, a whole application, I received a rate quote of 7.875%. It was much closer to the as-low-as rate, though there was no indication as to whether there would be any fees charged. I inquired via email, and it appeared that there would be no fees applied in my case. Had I found the best loan for me? No, not even close. It turns out that SimpleTuition neglected to tell me about Federal Stafford loans, with rates of no more than 6.8%. And while the list included Federal Grad-Plus loans, I ignored them because the interest rate of 7.92% was higher than the rates I saw on listed private loans. Or so I thought. The important detail that I missed—because it’s not clear on the web site—was that the Grad-Plus loan rates are fixed, not variable like the private loans. That's a critical and potentially expensive distinction. Not all lenders try to push private loans ahead of Federal loans. For example, Wachovia strongly encourages students to get Federal loans before considering private loans. Contrast that with the treatment you get when seeking a student loan through LendingTree.com. The site directs you immediately to a private loan company. And if you express an interest in Federal loans instead of their more expensive private loan, you are told with an ominous lack of enthusiasm: "Federal Loans may be a good option for some families." In fact, Federal loans are the best place to start for nearly everyone. But wait! The lender list at GreentreeGazette.com shows that National City has private loans with zero interest. I applied. The promissory note arrived and I prepared to provide my electronic signature and get my loan. But I noticed that it said that my interest rate "margin" would be 4.25. I perused the rest of the document and found that the interest rate would be LIBOR plus the margin, which totals almost 10%. Plus 4% in fees. Another bad lead. The system is confusing enough without the added problem of colleges' advice being potentially tainted by conflicts of interest. Students in the lending maze need unbiased, knowledgeable advisors. That's the important role that college financial aid administrators should be playing in the process.

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