Private student lending hits $150 billion, creates debt trap | The Bell Policy Center

Private student lending hits $150 billion, creates debt trap

Americans owe more than $150 billion in outstanding private student loan debt, according to a report to Congress by the Consumer Financial Protection Bureau (CFPB).  The report estimates that the student loan market grew from less than $5 billion in 2001 to more than $20 billion in 2008. Last year, it fell sharply, to less than $6 billion, after tighter underwriting standards took effect.

The CFPB gathered data from studies conducted by the Department of Education, collected new marketwide data from the industry and called for public input.  The report is an analysis of private lenders, their products, the market and performance over time. In addition, the report looks at consumers of these products, their characteristics, and usage and repayment behaviors.

The private student loan product is an important component of higher education financing that was originally designed to supplement federal loans and grants. However, from 2005 through 2007, lenders aggressively marketed and disbursed loans directly to students rather than through schools. During this period, the percentage of loans made to students grew from 40 percent to more than 70 percent. According to the CFPB, these contracts were not well understood and the schools did not certify the borrower's financial needs.

Many students did not even exhaust their federal Stafford Loan limits before turning to the private loan product. They borrowed more than they needed to finance their education, and in many cases lenders overlooked credit worthiness of many of the borrowers, making the private student loans riskier for consumers.

According to the report, students at for-profit colleges were three times more likely to take out a private student loan compared to all undergraduates (42 percent to 14 percent). During this boom a large portion of student loan volume was funded by asset-backed securities. The report states that "... the private student loan market resembled the subprime mortgage market." Lenders increased volumes through a process they called direct-to-consumer lending. Such lending basically took out the involvement of the school's financial-aid office, reaching students directly through mass media, online advertising and direct media. Much of the funds were directly disbursed to the student, instead of to the school.

At the end of the boom, private student loan borrowers who started school in the 2003-04 academic year were graduating and facing 16 percent unemployment rates. Default rates on private student loans have spiked significantly since the financial crisis of 2008, exceeding $8 billion and representing more than 850,000 loans.

Richard Cordray, director of CFPB, recommends that Congress enhance the role of schools in the private student loan market and examine the appropriateness of allowing students to wipe out the loans in bankruptcy. Education Secretary Arne Duncan recommends that schools and lenders proactively protect and inform private student loan borrowers.

– George Awuor