Report to Congress: Some Private Lenders Engaged in ‘Risky’ Practices

Student loan borrowers have more than $150 billion in outstanding debt through private student loans, a sector of the financial aid market beset by “risky practices” that mirrored the problems in the mortgage lending market, Obama administration officials said Thursday.

Briefing reporters on a report sent to Congress on the topic, Consumer Financial Protection Bureau (CFPB) Director Richard Cordray said the fast-growing private market bore “striking similarities” to the home loan market before the mortgage meltdown, as some lenders engaged in aggressive marketing and risky underwriting.

“Our findings reveal that students were yet another group of consumers that were hurt by the boom and bust of the financial crisis,” Cordray said. “Too many student loan borrowers are struggling to pay off private student loans that they did not understand and cannot afford.”

From 2005 to 2007, lenders increasingly marketed and disbursed loans directly to students, bypassing institutions of higher education, CFPB’s new report says. Overall, the percent of loans to undergraduates made without colleges’ involvement or certification of need increased from 40 percent to more than 70 percent.

“As a result, many students borrowed more than they needed to finance their education,” the study said. Lenders also were “more likely” during this period to give loans to students with low credit scores, thereby increasing risk.

Another tactic among private lenders was marketing to students who had not exhausted their federal Stafford Loan limits, meaning these students did not take full advantage of federal loans available to them. About 40 percent of private student loan borrowers still had federal eligibility remaining, the report said, and many students told CFPB they did not understand the differences between federal and private loans.

Originally designed to supplement federal loans to pay rising tuition, private student loans grew dramatically from just $1 billion in 2001 to $20 billion in 2008 alone as students and their families sought new ways to meet college costs. Under the Dodd-Frank consumer protection law, the federal government authorized a study to Congress on the topic.

“Subprime-style lending went to college and now students are paying the price,” said U.S. Education Secretary Arne Duncan. The findings point to the need for students and their families to regard federally backed loans as “the first option” for borrowing, he added.

The report to banking and education committees in the House and Senate says private loans are “riskier” in part because they lack the flexible repayment options available under federal loans. “Some borrowers reported that they did not know they had fewer options when repaying their private student loans than they did with their federal student loans,” the study said.

Private loans are particularly popular at for-profit colleges, the report noted. Forty-two percent of students at these colleges took out a private loan in 2008, compared with 14 percent of all undergraduates.

In 2009, the unemployment rate was 16 percent for private student loan borrowers who had started school in 2003-2004, the report said. With the explosion in lending and the uneven economy, it stated, default rates “have spiked significantly” since the 2008 financial crisis.

CFPB and the Education Department are recommending what they term “common sense” recommendations to improve the private market. They say lenders and college financial aid counselors should work together to make sure borrowers have more information on their debt obligations. Lenders also need to adopt valid underwriting standards.

CFPB also has an online Student Loan Debt Collection Assistant to help borrowers who have missed payments on their private or federal student loans. The tool can help them better understand their options and communicate with their lenders. For more information, visit www.consumerfinance.gov.