A hidden hazard of private student loans
(MoneyWatch) Here is one of the biggest risks of taking out a private student loan that most people never think about: It's extremely difficult to refinance.
Borrowers are typically unable to refinance private college loans, especially given that their credit history is often thin or nonexistent. Even when people with student loans have found great jobs and have established excellent credit histories, few if any lenders will consider lowering their rates through refinancing.
This dilemma is one reason why more than 850,000 private student loans, which in total are worth more than $8 billion, are in default.
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Meanwhile, there are few opportunities for refinancing private student loans at lower rates. According to Mark Kantrowitz, a nationally recognized financial aid authority and the publisher of FastWeb and FinAid.com, there are only a half dozen private consolidation loan programs, and the total capital for consolidating private student loans is limited.
The federal Consumer Financial Protection Bureau is now asking borrowers, parents, educators and business leaders to offer suggestions on how the private college lending mess can be fixed. In a six-page letter to the CFPB, Kantrowitz outlined numerous ways to provide financial relief to borrowers. Here are four of them:
1. Congress could allow private student loan borrowers to refinance their loans into federal student loans, up to the borrower's remaining federal student loan eligibility. Federal student loans offer a safety net for struggling borrowers through government-sponsored repayment plans.
2. Borrowers could be required to undergo financial literacy and debt management counseling before refinancing their loans. This would add value by improving the credit quality of the loan portfolio.
3. Eliminate the law barring student loans from being discharged in bankruptcy. This would provide financial relief, but it would also encourage lenders to compromise with borrowers for fear that they might lose loans in bankruptcy court.
4. Lenders should offer borrowers who are behind on their payments options for rehabilitating their loans. Lenders could restore borrowers' good credit after making so many on-time payments.
If you have any ideas about how the private college loan system can be fixed, the CFPB wants to hear from you by April 8. You can learn more by visiting the the bureau's website.
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Student loan justice, you make some great points. Indeed, private loans have changed and are now highly regulated with consumer protections. A return to market discipline is welcome. The controversy needs to be taught so that citizens can make a decision that's fair and equitable. Education has a wide reaching societal impact, and how it's paid for matters.
Virtually all other forms of debt have bankruptcy protections in place, but all of the underwriting and interest rate structures for these debt instruments (Like car loans, credit cards) build this risk into their pricing models. Financial institutions pay for insurance in case the borrower defaults or declares bankruptcy, so that their is a fair transfer of obligations to another party. It's efficient and yields jobs to the economy in a dynamic market place.
Then there are federal student loans. No underwriting (or lax underwriting for Plus loans). Guaranteed approvals for everyone that applies. The same interest rate for every person, regardless of their credit or their ability to repay or major. No incentive for anyone with good credit. The new PAYE and IBR repayment plans can extend terms to reduce minimum payments, but is that really a viable debt solution, extend and pretend? It's a band aid, and as SLJ points out the "legislation quietly dies" before the issue can really be examined.
My question is how would interest rate pricing models and approvals be affected if bankruptcy protections were reinstated? Should Federal Direct Loans continue to guarantee approvals in such an environment? We got Edulanchpad and SLJ in here, some heavy hitters on the Blogosphere, chime in please.
Also, I write on behalf of Credit Unions around the country that are actively providing private student loan consolidations. They hold fair underwriting standards that when met provide reduced interest rates and improved repayment terms. I've seen loans at 14% get reduced to 4.75% through the consolidation, and we hope to provide this relief to as many as possible. Unfortunately it is impossible for everyone to be qualified for approval. I agree that allowing private loan providers to dump under-performing loans onto the tax payers is unfair, and we should all tread lightly when dealing with any legislation that would promote this.
For private loans, returning bankruptcy should compel a return to pre-2005 underwriting standards. I suspect that both interest rates and approvals will be affected, and this is precisely what is desired from the citizen's point of view. This tightening is precisely what is needed so that Colleges won't be able to raise their tuitions to where the students must get supplemental private loans in addition to their federal loans. I hope, in fact, that many will be forced to lower their tuitions, or lose the student. I suspect that almost no students will be kicked to the curb, but if some are forced to attend a less expensive school as a result, this is a far better outcome than the overpriced environment we face now, and also the incredibly high default rate. Please also don't forget the financial terror that is being inflicted on borrowers by the banks, where they are hit with penalties, fees, etc that would make a mobster blush, and often their parents or grandparents wealth come under serious threat, with no recourse but to pay the massively inflated amount.
For federal loans, I would expect to see a return of meaningful oversight by the Department of Education on these loans, which could very well mean underwriting standards, federal loan limits being reigned in, and new attention paid to the quality of the schools, and their costs. The Department has grossly neglected to perform these types of oversight activities for years, so this, too, will be a welcome change that should definately reduce defaults, decrease prices, and improve quality for the students. I don't see a downside, here, although the schools will grumble somewhat.
However, their lack to understanding that the driver for those expected long term returns is not the education the student receive but the marketplace itself, is sheer stupidity on their part. Without having a strong economy in place, one that provides a sustainable level of individual and ongoing job growth, their wallets will suffer.
Both the public and the private sectors ignored the economic climate, knowing full well the inherent risk in their investment. Now, because of simple and controlling law adjustments, they hope to fully burden the individuals by threatening them and their family with a helpless and hopeless situation created by their greedy misjudgments.
I do agree with you that federal takeover of the loan debacle is a bad idea. Bankruptcy protection needs to be reinstated. This is the only way to put discipline back into the student loan market. Right now, loan providers have little incentive to be judicious in approving student loans. As long as these loans have no bankruptcy protection, the loan providers know they have someone on the hook for as long as it takes.
Now reinstating bankruptcy protection will not be a panacea. Many students will find it harder to get a loan because it will force lenders to more closely evaluate the borrowers. In my mind, this is not a bad thing. It would go a long way to cutting down on students borrowing insane amounts of money for college, and force them to evaluate college with a much more keen financial eye.
Elizabeth Warren understands the systemic importance of bankruptcy protections for a lending system. Every conservative, free-market economist knows it as well. The fact that the citizens are having to do anything more than point out this systemic failure to get this protection back for these loans is troubling, and if the bank lobby continue to keep their foot on the head of the borrowers in this way, then the lending system will surely lose all legitimacy, and those holding the paper will be lucky to get a nickel on the dollar, despite whatever rosy forecasts they may be clinging to.
There are more than a few citizens who have been following this problem for years, doing good research, and breaking stories on this issue, and they are by and large talked over by so-called experts who have been spoonfeeding this issue to the press for years (and we are now seeing the results).
The points I make in my comment are only a few of the salient points that almost never make it into the conversation, but they are critically important, and correct a litany of misinformation designed to lull the public into complacency when they (and Congress) should be pounding their fists on the table based on the facts of the matter.
This so-called "refinancing" looks and smells like a ploy to provide yet another bailout to the private lenders, who would like nothing better than to offload the horrible, non-performing loans they made to onto the backs of the taxpayer for full book value. This is not refinancing, its another example of shameless corporate welfare for the banks.
Borrowers beware: Despite the friendly sounding characterizations for federal loans, they have FEWER consumer protections than private loans. There is also a behemoth collection scam behind them that should be far more widely reported.
These repayment programs are untested, and in all likelihood will be administered in such a way as to kick as many people out of the program as possible.
The citizens desperately need plain, simple clarity from the CFPB. For private loans, this would mean simply pushing for the return of the bankruptcy protections that should have never been taken away...Instead, we get this big government "refinancing" scheme that not only leaves bankruptcy protections absent, but also will harm greatly the majority of borrowers who sign up for it, get booted out of the program owing far, far more than when they came in!!
Funny how every time bankruptcy legislation comes around for student loans, alternative proposals like this explode into the conversation, and the bankruptcy legislation quietly dies. This is how it has been for the past 8 years...this false drama between private and federal (ie black hat vs. white hat), bankruptcy legislation only for private loans, with the twist that even that legislation has been essentially derailed because everyone (including the "progressives") pushes various repayment programs instead of bankruptcy...thus the one becomes a cheap, political substitute for the other.
Come on People. Don't fall for this scheme again. It's been pulled too many times. This is how the bad people in Washington D.C. win.