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Private student loans are the fastest-growing sector of the multibillion-dollar student loan industry. In 2005-06, college students borrowed a record $17.3 billion in private loans, up 913% from a decade ago, according to a report issued Tuesday by the College Board.
At a time when the cost of college is surging and financial aid is shrinking, private student loans make it possible for many students to attend colleges they couldn't otherwise afford. But consumer advocates and student groups worry that the growth of these loans could prove disastrous for borrowers who don't understand the risks.
4 year Public College
Tution & Fees -
- $5492 (2005-06)
- $5836 (2006-07)
- Room & Board
- $6623 (2005-06)
- $6960 (2006-07)
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4 year Private College
- Tution & Fees
- $20,980 (2005-06)
- $7763 (2006-07)
- Room & Board
- $22218 (2005-06)
- $8149 (2006-07)
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Unlike federal student loans, private loans aren't guaranteed by the federal government. While guaranteed student loans carry a fixed rate of 6.8%, there are no limits on the interest rates and fees private lenders can charge. Some have variable rates of up to 19%.
Once primarily used by graduate and professional students, private loans are becoming increasingly popular with undergrads. Nearly 85% of private loans provided by student lending giant Sallie Mae go to undergraduate students, up from 72% five years ago, says Barry Goulding, a Sallie Mae senior vice president.
While federal Stafford loans are available to all students regardless of their credit history, private lenders check a borrower's credit report before making loans. Students who have no credit history, or poor credit, will typically pay higher rates than those with a good credit history or those with a parent who will co-sign the loan. As a result, the poorest students end up with the most expensive loans, says Luke Swarthout, associate at the State Public Interest Research Groups' Higher Education Project.
Limits on federal student loans :-
The total amount undergraduates who are dependents can borrow through the federal Stafford loan program is $23,000, an amount that hasn't changed since 1992. During the same period, the average annual cost of college tuition and room and board at public, four-year colleges has risen 135% to $12,796 this year, according to the College Board.
In addition to the overall limit, there are caps on the amount undergraduates can borrow each year. On July 1, 2007, the amount of Stafford loans college freshmen can borrow will rise to $3,500 from $2,625, while limits for sophomores will increase to $4,500 from $3,500. But that's still well short of the annual cost of attending many private — and even some public — colleges.
The amount of aid available for low-income students has also stagnated. The maximum Pell Grant, the most common form of direct federal aid for low-income students, is $4,050, a sum Congress hasn't raised since 2003. The most available under the Perkins program, which provides low-interest loans to students with "exceptional" financial need, is $4,000 a year.
As a result, private loans have become a necessity for a lot of families. Many students, though, aren't getting the message. A 2003 analysis by the Public Interest Research Groups found that nearly half of undergraduates with private loans did not first borrow the maximum available from the Stafford program. About a quarter of those students bypassed the federal loan program entirely.
Financial pressures on parents :-
Parents of undergraduate students can supplement their children's aid and loan packages with a Federal Parent Loan to Undergraduate Students, or PLUS loan. PLUS loans carry a fixed rate of 8.5%.
The credit standards for these loans are less stringent than those for private loans, and parents can borrow up to the full cost of college.
But parents are increasingly reluctant to borrow for their children's education, lenders and financial aid directors say. Over the past decade, the amount borrowed from the PLUS program has grown at a far slower rate than the amount borrowed from private student loan lenders.
Co-signing typically provides more favorable rates for student borrowers, but it doesn't get parents off the hook. If the borrower can't make payments, the parents who co-sign are then responsible.
Current interest rates are relatively low, rates on many co-signed private loans are lower than PLUS loan rates. But some borrowers might not realize that private loans are like adjustable-rate mortgages (ARM) i.e. If interest rates rise, the rates on their loans will go up, too.
Loans for life :-
Private lenders insist the long-term benefits of a college education are worth the extra cost of a private loan. Even if it's at a slightly higher rate, it still helps the students pull themselves up and live the life they want to live.
But if borrowers are unable to find well-paying jobs, they could run into serious financial trouble. Borrowers who are unemployed or suffering economic hardship are entitled to defer payments on their federal loans for up to three years.
Private lenders aren't required to offer hardship deferments, though some do so voluntarily.
In addition, a provision included in the stricter bankruptcy law that took effect last year makes it nearly impossible for borrowers who file for Chapter 7 bankruptcy to erase private student loans. Under the law, borrowers with private loans must show "undue hardship," the same strict standard that applies to federal loans.
Borrowers must convince the court that they'll never earn enough money to repay the loan — an unattainable standard unless the individual is permanently disabled, bankruptcy attorneys say.
Consumer groups counter that providers of private student loans don't deserve special bankruptcy protection, because there are no limits on the fees or interest rates they can charge borrowers. And because these loans lack protections included in federal loans, some borrowers could spend the rest of their lives paying off high-interest student loans, they say.
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