Viewed as problematic by student advocates because of high interest rates and a lack of consumer protections, private student loans have expanded nationally by 590 percent in the last 10 years.
Their growth correlates with rising tuition and a cozy relationship between some schools and private lenders, as well as a demand for bundled student loans in financial markets.
Rising College Costs
Costs related to higher education grew 79 percent at public schools and 65 percent at private schools in the last ten years, according to a recent report from College Board , a nonprofit organization dealing with higher education issues.
At the same time as costs increased, upper limits on federal loans remained stagnant until last year, for example, at $23,000 dollars for undergraduates.
This mostly affected graduate students and students at private colleges who spent more than the federal loan limit and were forced to rely on private loans, Project on Student Debt communications director Edie Irons said.
“A lot of people graduate from medical school with $200,000 dollars in debt,” she said. “Federal loans just weren’t available to that amount.”
Federal loan limits were increased this year in the Ensuring Continued Access to Student Loans Act , which earned bipartisan support in Washington.
“Gopher Advantage Loan”
A cozy relationship between private lenders and some schools was another factor in the growth of private loans in the last decade.
A 2007 investigation by New York Attorney General Andrew Cuomo found lenders paid schools to be placed on “preferred lender” lists in violation of standards set in the 1965 Higher Education Act.
The relationship included revenue sharing agreements, as well as financial officers being paid outright, including the case of Minneapolis-based Capella University where a financial aid officer was paid $12,000 dollars by private lenders.
Similar practices were widespread, especially in private schools, Irons said.
“They’d call it like the ‘Gopher Advantage Loan’ and that gives students a false sense of security,” Irons said.
Most involved colleges paid settlements last year and Congress instituted a code of conduct that went into effect this year.
However, experts say that the restrictions on lenders’ relationships to schools gave lenders more reasons to pursue students through direct marketing where there are fewer safeguards.
In September 2007, after Cuomo’s investigation had started, Sallie Mae , which controls 45 percent of the private student loan market, requested the names, phone numbers, e-mail and mailing addresses of students at state universities and community colleges in three states for direct marketing purposes — including promoting private loans.
Sallie Mae communications representative Erica Eriksdotter said the purpose of the letter was to reach clients with their “1-2-3 approach to paying for college,” which places a priority on utilizing federal loans before borrowing private loans — both of which Salle Mae disburses.
The secondary market
Part of the reason private loans were rare until a decade ago is that students had very little to put up for collateral in exchange for a loan, Senior Policy Analyst and economics professor at Skidmore College Sandy Baum said.
“You can’t put your education up for collateral,” Baum said. “The federal government actually developed federal student loans because it was obvious the private market wasn’t going to do a good job for students because of the lack of collateral.”
For Sallie Mae, private loans earn an average of 5 percent profit while federal loans they disburse earn only 2 percent profit.
Much like during the sub-prime mortgage debacle, private lenders bundled student loans and sold them to speculators worldwide, she said.
Demand for private student loan-backed securities jumped 76 percent in 2006, to $16.6 billion according to Moody’s Investor Service . As demand grew, lenders often made more risky loans to fulfill it.
“This was a very profitable business,” Baum said. “Now all these lenders are in trouble and things don’t look so profitable.”
The Treasury announced last week it was planning to use $2 billion of the federal bailout to prop up lenders, including those who lend to students.
The 2005 bankruptcy bill made private loans almost impossible to erase in bankruptcy even though they don’t fulfill the conditions usually demanded by the federal government, Irons said.
“That means a consumer spends thousands of dollars buying jet skis on their credit card can get relief in bankruptcy, but a teacher who borrowed private student loans and can’t work because of a disability has almost no way out of that debt,” Irons said.
The change was brought on by the lending firms’ lobbying efforts, she said.
Finance and credit agencies have given $6.5 million in political donations and spent $24 million on lobbying so far in 2008, according to the Center for Responsive Politics .
By itself, Sallie Mae spent $2.6 million on lobbyists in the first quarter of 2008. Its lobbyists focused partly on the Student Loan Sunshine Act and the Financial Aid Accountability and Transparency Act — both of which guided the behavior of private lenders and forced them to disclose more information to borrowers.
In a letter to a group of Senators including Sen. Ted Kennedy, D-Mass., Sallie Mae Vice President of Federal Relations, Timothy J. Morrison , voiced the company’s disapproval of “overly broad disclosure[s] of borrowers’ personal loan information”, that the bill would demand.
Because of the lack of these consumer protections, and the fact that interest rates are normally higher for students with worse credit, it’s often harder for borrowers to dig themselves out of a difficult financial situation, Project on Student Debt’s Irons said
“The one option that private loan providers provide is usually what’s called forbearance, which is a temporary postponement of payments, but interest accrues during forbearance,” she said.
According to Sallie Mae, default rates on its private loans rose from 3.16 percent to 3.60 percent between the fourth quarter of 2007 and 2008.
Although there have been some recent reforms regarding the marketing and disclosures of private loans, more are necessary, Irons said.
“Where there’s still no real regulation or meaningful protections for borrowers is on the repayment side,” she said. “We need better consumer protections for those folks than are currently available.”