Student Loan Crisis?
Fear not: The mortgage crisis hasn’t doomed the student loan industry.
By Ben Miller
June 10, 2008
(iStockPhoto.com)Over the past few months, some student loan companies made news by announcing they’d no longer be lending to students. The credit crisis, it seemed, had finally hit young people. To some degree, the crisis is overblown: The law guarantees some types of student loans and such loans are available for every student regardless of income or credit rating. But there are concerns that broad problems in the credit markets could prevent some individuals from obtaining federally guaranteed funds. Unfortunately, discussions of aid availability are often shrouded by misinformation that raises fears about a widespread student lender crisis.
Last school year, nearly 40 percent of all undergraduates—about 6.8 million individuals—took out a total of $39 billion in federal loans. That’s an increase of more than 50 percent in loan volume and nearly 60 percent in number of borrowers over the last decade.
The first thing to realize is that there are two different types of loans: Stafford loans and Parent Loans for Undergraduate Students, more commonly referred to as PLUS loans. Stafford loans are more common and are available for all students, regardless of income, that meet minimum eligibility requirements. Low-income Stafford borrowers, however, receive a few additional benefits such as an interest rate that is will be halved over the next few years. If Stafford loans aren’t sufficient to cover all educational expenses, like housing and books, borrowers and families can also take out PLUS loans. Unlike Stafford loans, which are borrowed in the student’s name, parents or guardians take out PLUS loans at a slightly higher interest rate with larger limits. Parents can take out any amount up to the cost of attendance minus any other financial aid received. PLUS loans, however, are not an entitlement; parents with bad credit can be rejected.
Second, students and parents have two systems that distribute student aid depending on which federal program their school uses. Roughly 80 percent of borrowers participate in the Federal Family Education Loan (FFEL) Program, where private companies disburse federal loans. As an incentive for making these loans, lenders receive quarterly compensation from the government, known as special allowance payments (SAPs). In addition, the government pays lenders 97 percent of the value of any defaulted loan. This means lenders carry very little risk when lending under FEEL. The other 20 percent of borrowers receive their funds straight from the Department of Education through the Federal Direct Loan Program. The Department uses Treasury funds to disburse funds directly to a borrower’s school.
Fact and Fiction
The two loan systems covered every borrower without trouble until problems in the credit markets began making it difficult for FFEL companies to obtain the financing necessary to disburse new loans. This caused some larger lenders, such as the Pennsylvania Higher Education Assistance Authority, to exit the market, and led to concerns that students would not be able to obtain FFEL loans. Unfortunately, there is much misinformation about the root causes of credit problems and the potential harm to borrowers out there.
FICTION: Congressional action caused the loan “crisis”
Last fall, Congress passed the College Cost Reduction and Access Act, which increased aid for low-income students by reducing the size of the quarterly payments being given to lenders. Once the credit markets worsened, some lenders and members of Congress claimed that the subsidy cuts were to blame for companies’ reluctance to make loans. The subsidy cuts did diminish the outsized lender profits, but lending troubles ultimately stemmed from a global lack of available liquidity. With fewer investors willing to buy the bonds and other securities loan companies issue to get capital to make new loans, lender borrowing costs increased substantially. This shrunk or eliminated the companies’ profit margins—the difference between the cost at which they borrow money and the quarterly government payments they receive. A return of investors to the market would lower borrowing costs and make loans profitable again.
FICTION: Federal student loans will now be hard to get
To date there haven’t been any reported cases of students being unable to obtain a FFEL loan. Several dozen lenders have left the program, but the largest companies, such as Sallie Mae, are still participating. Meanwhile, some lenders that initially dropped out rejoined the market following recent Congressional action.
Even if a large number of lenders were to exit the market, there are two other ways to get access to loans, both of which offer nearly identical borrowers terms as FFEL loans. The first option would be for schools to switch to direct lending, an avenue that an estimated 20 percent of schools are considering. Sizeable institutions, such as Michigan State University, Northeastern University and Penn State University have all made the switch. The use of Treasury funds to make direct loans means students enrolled in these schools will be unaffected by problems in the credit markets.
The second backup system is known as lender-of-last-resort. Under this program, students who have received at least one FFEL denial are automatically eligible to receive a Stafford Loan from a non-profit entity known as a guaranty agency. These are middlemen who administer the federal default insurance on FFEL loans. Guaranty agencies are required to either offer loans-of-last-resort or find a lender who is willing to make them. Therefore, any student denied by a conventional FFEL lender should have a source that is legally compelled to provide a loan.
FACT: The federal government has ensured loan availability
On May 7, President George W. Bush signed a bill that contains a number of provisions to ensure student loan availability. The legislation gives the Department of Education the authority to purchase existing student loans or buy shares of newly issued loans. The former provides companies with additional capital to make loans, while the latter will serve as a low-interest loan to lessen borrowing costs and make loans more profitable.
In addition to helping FFEL lenders, the Department of Education has also prepared for an increase in the number of schools entering into direct lending and is capable of quickly doubling the size of that program.
FACT: Non-federal student loans may be harder to obtain
Government action should ensure that all students receive federal loans, but some individuals may have trouble obtaining private loans. These are student loans that carry no federal insurance, have substantially higher interest rates, and can be denied to students with poor credit. Some lenders have announced that they will tighten their standards for making private loans. This includes higher required credit scores and the wholesale exclusion of some for-profit trade schools and community colleges that have large numbers of students default on their loans. However, lenders likely would have pulled away from these schools even before the credit crunch. Sallie Mae’s chief executive Albert L. Lord recently admitted that the company’s sub-prime lending practices were “a mistake.” The company has lost hundreds of millions of dollars on those loans.
PLUS loans may also be harder to obtain because parents can be turned down on the basis of a credit check. There are, however, options for borrowers unable to obtain PLUS or private loans. The recently passed Congressional legislation included a $2,000 increase in Stafford loan limits, allowing dependent borrowers to take out up to $5,500 as freshmen and a total of $31,000 over four years. Independent borrowers can take out even more—$9,500 for freshmen and a lifetime cap of $57,500. These higher loan limits should be enough to cover the vast majority of the cost of attendance at a community college. Meanwhile, students whose parents are denied a PLUS loan automatically have their Stafford loan limits double.
FACT: There are flaws in the government’s solution to the credit crunch
Government action should be sufficient to keep lenders in the market, but does not address the lack of compulsory participation in the FFEL Program. Congress sets the lender subsidies and hopes they are sufficient to attract companies. This inefficient process means sometimes the subsidies are too high, leading to wasteful government spending, while other times they are too low, creating potential loan shortages as lenders threaten to drop out. The voluntary one-subsidy-fits-all approach also allows lenders to selectively avoid community colleges and other institutions with poorer student populations and higher loan default rates—putting the neediest individuals most at risk of losing access to federal loans.
The congressional solution to the credit crunch fails to alter this paradigm, and instead provides a different type of temporary subsidy. Were lenders to enter a system where they submitted bids for the subsidy at which they would enter a contract to make loans, there would never be concerns about whether there were enough companies in the market.
The peak student lending season will begin shortly, which should reveal what was reality and what was rhetoric in the debate over the credit crunch’s effect on student loans. Congress and schools have taken numerous steps to ensure that all students looking for a federal loan should be able to receive one. Don’t fall for the panic raised by big-company lenders. But be smart. If you have any concerns about loan availability, contact your school’s financial aid office, which can help you find a lender.
Ben Miller is a Program Associate of the Education Policy Program at the New America Foundation and writes for Ed Policy Watch. He graduated from Brown University in 2007.
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— Matt Kresling - Jun 26, 04:06 AM - #hi, is there any other way I can get a loan with out a co signer, and without a federal loan, I have tried everything and they way it looks I’m not going to be able to attend school :(
— Gabrielle Hughes - Jul 29, 05:13 PM - #