Private loans grow 590 percent

EditorâÄôs note: This is the first in a two-part series looking at the expansion of private student loans. TomorrowâÄôs will look at student loans and the bailout bill. Viewed as problematic by student advocates because of high interest rates and a lack of consumer protections, private student loans have expanded nationally by 590 percent in the last 10 years. Their growth correlates with rising tuition and a cozy relationship between some schools and private lenders, as well as a demand for bundled student loans in financial markets. Rising College Costs Costs related to higher education grew 79 percent at public schools and 65 percent at private schools in the last ten years, according to a recent report from College Board , a nonprofit organization dealing with higher education issues. At the same time as costs increased, upper limits on federal loans remained stagnant until last year, for example, at $23,000 dollars for undergraduates. This mostly affected graduate students and students at private colleges who spent more than the federal loan limit and were forced to rely on private loans, Project on Student Debt communications director Edie Irons said. âÄúA lot of people graduate from medical school with $200,000 dollars in debt,âÄù she said. âÄúFederal loans just werenâÄôt available to that amount.âÄù Federal loan limits were increased this year in the Ensuring Continued Access to Student Loans Act , which earned bipartisan support in Washington. âÄúGopher Advantage LoanâÄù A cozy relationship between private lenders and some schools was another factor in the growth of private loans in the last decade. A 2007 investigation by New York Attorney General Andrew Cuomo found lenders paid schools to be placed on âÄúpreferred lenderâÄù lists in violation of standards set in the 1965 Higher Education Act. The relationship included revenue sharing agreements, as well as financial officers being paid outright, including the case of Minneapolis-based Capella University where a financial aid officer was paid $12,000 dollars by private lenders. Similar practices were widespread, especially in private schools, Irons said. âÄúTheyâÄôd call it like the âÄòGopher Advantage LoanâÄô and that gives students a false sense of security,âÄù Irons said. Most involved colleges paid settlements last year and Congress instituted a code of conduct that went into effect this year. However, experts say that the restrictions on lendersâÄô relationships to schools gave lenders more reasons to pursue students through direct marketing where there are fewer safeguards. In September 2007, after CuomoâÄôs investigation had started, Sallie Mae , which controls 45 percent of the private student loan market, requested the names, phone numbers, e-mail and mailing addresses of students at state universities and community colleges in three states for direct marketing purposes âÄî including promoting private loans. Sallie Mae communications representative Erica Eriksdotter said the purpose of the letter was to reach clients with their âÄú1-2-3 approach to paying for college,âÄù which places a priority on utilizing federal loans before borrowing private loans âÄî both of which Salle Mae disburses. The secondary market Part of the reason private loans were rare until a decade ago is that students had very little to put up for collateral in exchange for a loan, Senior Policy Analyst and economics professor at Skidmore College Sandy Baum said. âÄúYou canâÄôt put your education up for collateral,âÄù Baum said. âÄúThe federal government actually developed federal student loans because it was obvious the private market wasnâÄôt going to do a good job for students because of the lack of collateral.âÄù For Sallie Mae, private loans earn an average of 5 percent profit while federal loans they disburse earn only 2 percent profit. Much like during the sub-prime mortgage debacle, private lenders bundled student loans and sold them to speculators worldwide, she said. Demand for private student loan-backed securities jumped 76 percent in 2006, to $16.6 billion according to MoodyâÄôs Investor Service . As demand grew, lenders often made more risky loans to fulfill it. âÄúThis was a very profitable business,âÄù Baum said. âÄúNow all these lenders are in trouble and things donâÄôt look so profitable.âÄù The Treasury announced last week it was planning to use $2 billion of the federal bailout to prop up lenders, including those who lend to students. Consumer debt The 2005 bankruptcy bill made private loans almost impossible to erase in bankruptcy even though they donâÄôt fulfill the conditions usually demanded by the federal government, Irons said. âÄúThat means a consumer spends thousands of dollars buying jet skis on their credit card can get relief in bankruptcy, but a teacher who borrowed private student loans and canâÄôt work because of a disability has almost no way out of that debt,âÄù Irons said. The change was brought on by the lending firmsâÄô lobbying efforts, she said. Finance and credit agencies have given $6.5 million in political donations and spent $24 million on lobbying so far in 2008, according to the Center for Responsive Politics . By itself, Sallie Mae spent $2.6 million on lobbyists in the first quarter of 2008. Its lobbyists focused partly on the Student Loan Sunshine Act and the Financial Aid Accountability and Transparency Act âÄî both of which guided the behavior of private lenders and forced them to disclose more information to borrowers. In a letter to a group of Senators including Sen. Ted Kennedy, D-Mass., Sallie Mae Vice President of Federal Relations, Timothy J. Morrison , voiced the companyâÄôs disapproval of âÄúoverly broad disclosure[s] of borrowersâÄô personal loan informationâÄù, that the bill would demand. Because of the lack of these consumer protections, and the fact that interest rates are normally higher for students with worse credit, itâÄôs often harder for borrowers to dig themselves out of a difficult financial situation, Project on Student DebtâÄôs Irons said âÄúThe one option that private loan providers provide is usually whatâÄôs called forbearance, which is a temporary postponement of payments, but interest accrues during forbearance,âÄù she said. According to Sallie Mae, default rates on its private loans rose from 3.16 percent to 3.60 percent between the fourth quarter of 2007 and 2008. Although there have been some recent reforms regarding the marketing and disclosures of private loans, more are necessary, Irons said. âÄúWhere thereâÄôs still no real regulation or meaningful protections for borrowers is on the repayment side,âÄù she said. âÄúWe need better consumer protections for those folks than are currently available.âÄù