Private student loans more problematic than helpful
Have you ever wondered why students pay such high interest rates to borrow funds for education? If you haven’t, you should. The logical answer is that loans to students with no income are risky. This is completely true. But my bets are that private lenders are not charging only for the additional risk. They are also taking advantage of unsophisticated, unsuspecting student borrowers, as well as not being fully transparent about the rates borrowers may or may not qualify for.
First off, let’s not confuse federal loans with private loans. Federal loan rates are regulated by the government and are fairly disclosed to borrowers. The rates typically do not vary based on a borrower’s creditworthiness. Private lenders, however, charge interest rates that are often significantly higher than comparable rates on federal loans. Rates also vary based on creditworthiness, or so the lenders claim. Furthermore, these rates are not disclosed in the same transparent manner as federal rates.
Until the recent implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the private student loan industry was largely unregulated. Your guess is as good as mine as to why not. Regardless of the reason, Dodd-Frank, which was passed following the 2008 credit crisis, changed this. Dodd-Frank established a Student Loan Ombudsman within the Consumer Financial Protection Bureau to oversee lending standards of private student loans. To date, the complaints within the ombudsman’s reports have focused on issues related to loan servicing, payment processing, accessing payment history and other issues applicable post loan-acceptance. There are few complaints, however, pertaining to issues related to interest rates and disclosures of the rates during the origination phase of the loan. Not all that helpful for those looking for more meritorious lending standards. And private lenders still don’t seem to be fairly disclosing their rates.
Take the following experience of a student borrower: following a recent loan application to Sallie Mae, the largest lender of private student loans, the Rate and Fee Disclosure — a document delineating a range of rates that a borrower may receive and the payments associated with each — indicated that the borrower’s fixed rate would be between 5.750 and 12.875 percent. The borrower was ultimately offered a rate of 8.875 percent, more-or-less in middle of the range. The borrower had the characteristics of what one would expect of a student borrower — no job, but using a co-signer with an established job, good credit, and earning a six-digit salary. Clearly, this student did not receive a rate anywhere near the bottom of the range disclosed. Which begs the question of how many student borrowers actually receive rates toward the lower end of the disclosed range? What factors really go into interest rate decisions?
It’s not negligible either. Every point — industry jargon for one percentage — makes a difference. On a $3,000 loan with a fixed interest rate of 8.875 percent and a deferred payment plan (interest accrues but is not due until after graduation) payable over 72 months following graduation, a typical borrower would pay a total of $5,283. This would include $2,283 of interest. A one-point decrease to 7.875 percent would lower the total payments by $321, lowering the interest payments by almost 15 percent over the life of the loan. Now you tell me if each point matters.
I stand by my bet that there is more than risk and creditworthiness that goes into interest rate decisions on private student loans. But perhaps we can change this.
Take action. You’re probably thinking to yourself, “So why doesn’t someone do something about it?” The problem is that data on private student loan rates are not publically available to the extent that data on federal loans are. Detailed data are likely in the hands of the lenders and servicers themselves. And they have little incentive to disclose the information. So how can we find out if lenders are taking advantage of unsophisticated borrowers? We can collect our own data. And you can help. If you have a private student loan, tell us about it by completing a 10-minute survey at privatestudentloansurvey.com. After completing the survey, you will be entered into a drawing to win an iPad. So take ten minutes, and help us help you.
Mark Wallach is a Rutgers-Newark Business School student majoring in finance and accounting.