Private Student Loans: 6 Ways to Make Them Better
Private student lenders swing wide their doors in August, when families struggle to raise the money needed for this school year. You can borrow from banks, some credit unions, and specialized institutions such as Sallie Mae.
New laws and regulations have cleaned up some of the misleading tactics families faced in the past. For example, all federal student loans now go through the colleges, not the banks, which stops banks from peddling private loans as part of the package. Also, the lenders now have to disclose your loan's costs and monthly payments three different times -- first, when you apply, then when you're accepted (and costs are adjusted, depending on your credit history), and finally when the money is disbursed. That limits the chance of bait-and-switch.
But there's more to be done, and the new Consumer Financial Protection Bureau has the authority to do it. You should always look first for federal and state education loans because they carry low fixed interest rates and attractive repayment terms. In the private marketplace, here are six added safeguards that ought to be put in place -- and that you should remember when borrowing this year:
1. The disclosure rules for private loans aren't tight enough. For one thing, they should apply to telephone solicitations, as well as applications in person and online. Right now, a salesperson can skip the upfront disclosure if you give your approval while you're still on the phone. Online, you might not get the disclosure until you're deep into the application. You ought to be able to see (and hear) it first.
2. Schools should certify every private student and parent loan, to be sure that the family isn't borrowing too much. Certification specifies the maximum, legal loan amount -- figured as the cost of attendance minus any financial aid the student gets. Currently, students self-certify, which leaves room for error. Schools often check the loan amount but they don't have to. If the private loan goes to the parents, certification isn't required. Students who over-borrow run more risk of default.
Mark Kantrowitz, president of FinAid.org, warns parents that over-borrowing can harm their child in another way. If they take an uncertified loan that exceeds the cost of education, and the school discovers it, the student's aid package will be reduced.
Certification by schools also helps aid officers find the students who haven't tapped all the low-cost state and federal money that they're eligible for, says Lauren Asher, president of the Institute for College Access & Success. They might not need private loans at all.
3. Students should receive a statement every time they borrow, showing their cumulative federal and private loans. Furthermore, they should have to sign it. "I'm tired of reading, 'I didn't know what I owed,' on student comment boards," says Tim Ranzetta of Student Loan Analytics, which ranks private lenders based on average cost. "The more you put the facts in front of them, the better they might understand their obligations," he says.
4. Students should get counseling every time they borrow. Right now, there's counseling only for federal student loans, covering budgeting tips and repayment rules. It happens twice -- when the student takes his or her first loan and when it's time to repay. That's not enough, and it's not rigorous enough. Students should be asked to imagine how they'll repay every loan, including private loans. Grownups shouldn't let them shut their eyes to the burden they're taking on.
5. Lenders should offer more flexible repayment options. When students leave school, they might not find a job right away or might have to settle for low pay. Lenders should offer deferment options and repayment programs based on income, says Deanne Loonin, an attorney for the National Consumer Law Center. Some lenders do this voluntarily, but plenty of limitations hide in the fine print.
Congress should step up to the repayment problem, too. Federal student loans can't be discharged in bankruptcy, except in cases of special hardship. That's a reasonable way of protecting taxpayers. But lenders got Congress to make their private loans, including parent loans, non-dischargeable, too. That helped encourage the wave of subprime student lending that is now wrecking the credit scores of so many young people.
How bad are the default rates on subprime private loans? First Marblehead, which bundles and sells student loans into the marketplace, gave a hint in the 10-Q Form it recently filed with the Securities and Exchange Commission. Almost half of its 2004-2007 loans fell into its worst-performing category. Of those, almost half are expected to fall into default.
6. Financial aid offices should potentially be able to recommend third-party websites that compare loan costs, such as Overture Marketplace or Student Loan Analytics. The current rules on recommending lenders make that hard to do. This is Ranzetta's suggestion and he's talking his own interest here, but makes a point. The more that students consult sites like these, the more lenders will participate and the better the price competition. That sounds right to me.
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