The Consumer Financial Protection Bureau has delivered a report to the Senate Banking Committee on the rise of the private student loan industry. This industry took a hit after 2010, when the Affordable Care Act included a provision that ended the practice of private banks administering student loans guaranteed by the government, and just had the government issue the loans themselves. Private student debt origination grew from $5 billion in 2001 to $20 billion in 2008, but after the 2010 law, the market contracted to under $6 billion. The recession and tightening credit standards also had something to do with that.
But those loans from 2001 to 2008 are still out there, for the most part, particularly from the 2005-2007 period. And just like in the housing bubble, this period was characterized by reduced underwriting standards and a kind of “subprime” market. Increasingly, banks lent directly to the student, rather than through a college or university that verified the terms. CFPB found that borrowers had lower credit scores in this period than previously. Since this period and the financial crash, lending standards have tightened.
And the borrowers in these private loans, which have fewer repayment options and higher rates than the federal Stafford loans, are at high risk for default. With high unemployment rates for young people, these loans are becoming a huge burden. CFPB found that 10% of recent graduates have monthly payments on their student loans that exceed 25% of income. Given all the other items in an individual budget, that’s way too heavy a burden. So there’s no surprise that default rates have increased. You can see the difference between the Stafford Loans and the private student loans in this paragraph on page 12 of the report:
One final and critical difference between PSLs and the Stafford loans they emulate is the risk associated with future employment and the ability to repay. Stafford loans offer numerous adjustments for borrowers who have difficulty making payments. Income-based repayment and income-contingent repayment allow payments to be reduced, based on current income levels. Forbearance allows for a temporary
reduction or cessation of payments, potentially for many months at a time. Even for a borrower who falls into default at 270 days past due, there are still programs to
rehabilitate (cure) the default or consolidate to take the loan out of default. Rehabilitation even results in an adjustment of the default notation in the consumer’s credit report.28 With the exception of short-term forbearance periods, PSLs generally lack similar risk mitigation tools.
The key here is that students don’t typically know the difference between the federal loans and the private loans. They either got bad information or no information, and the resulting decisions led to preventable defaults. 850,000 loans have fallen into default since 2008.
CFPB made a number of recommendations for dealing with the private student loan market in this report. Thankfully, the changes to the direct federal loans have dampened the growth of this market significantly. Nonetheless, these are some good recommendations. CFPB would require school certification of private student loans, and more education to borrowers about their choices in financing higher education. They also want Congress to consider whether to allow private student loans to be discharged in bankruptcy proceedings. The Secretary of Education made the same recommendation, but it’s unclear if Congress will take it up. Under the 2005 bankruptcy bill, discharge of private student loan debt is not allowed. But it looks like Sallie Mae is on board:
Sallie Mae, the nation’s largest private issuer of student loans, said it would back a legislative change that would allow bankruptcy in limited cases. “Sallie Mae continues to support reform that would allow federal and private student loans to be dischargeable in bankruptcy for those who have made a good-faith effort to repay their student loans over a five- to seven-year period and still experience financial difficulty,” it said in a statement.
This is a smart report which will hopefully drive policy on a growing economic threat to our nation’s young people.