Private Student Loans and Interest Rates

05Aug08

Increasingly, unacceptably, college graduates face frightening balances on student loans due to misconceptions about private student loans. The basics:

Private student loans tend to fill funding gaps that federal planners allocate to PLUS loans. If circumstances divert the financial burden from parent to student, as often happens, then private loans sometimes enter the student loan mix. Since 67% of private loan borrowers are dependent students, one might tentatively expand on “sometimes,” or even wonder if the federal PLUS loan vision has failed.

Private student loans come from commercial lenders and are not federally insured against default, nor do they offer the wide range of benefits available from federal loans. Private student loans also operate on an entirely different interest rate schedule, which immediately confuses most students. A common example:

Citibank offers a private loan for undergraduates at an advertised 4.5% interest rate. Looking further, first, that rate only applies to students with near-perfect credit. Many students will qualify for 8%-13% rates. Second, it’s a variable interest rate calculated from current PRIME rates that may rise over the term of the loan. Third, repayment relief options are significantly less than federal loans. Unlike federal loan programs, no forgiveness programs exist for private student loans, and the loan will not be canceled if a school shut down or the borrower suffers a life-altering disability (federal loans offer this protection).

And this is Citibank, a reputable bank, offering an honest loan. Even if students understand the terms, they seem systematically to misjudge market fluctuations and ignore the risk of debilitating injury or prolonged joblessness.

One scenario:  interest rates have risen and students lose jobs due to recession.  When job markets stagnate, many scramble into deferral or forbearance – allowing principals to bloat from accrued interest – and seek interim jobs or shoot back to school with new loans.

This is a pure gamble, rolling dice for one’s life. Few understand what they’re doing. Soon deferral and forbearance will vanish, all years expended, and moving forward, forever, those swollen loans must be paid at even higher rates  with no graces for illness or unemployment. Whether or not a graduate can manage depends on how well his career has proceeded, an outcome tied to economics and fortune and so often beyond one’s control. Thousands of loan stories end here, in default.

Private loans troubles lurk beyond government data, steadily underreported. Private loans are not formally tracked. Students have no motive to report loans, and many firms do not disclose them.

The distinction of lending firm matters greatly. The large private lenders, banks, like Citibank, run publicly-traded businesses with rigorous rules and public disclosure. Their financial reports are widely read and basically tell the truth.

A separate set of lending institutions are privately traded and sparsely regulated – a tremendous edge for crooks. Deception is the only edge that smaller firms have on Citibank-sized institutions. Almost by rule, these firms are smaller and seedier, marketing loans directly to students and with a devil’s regard for students’ wellbeing.

They escape notice like this.

Filed under: Predatory Lending, Private Student Loans   |  1 Comment
Tags: Private Student Loan Problems, Private Student Loans, Student Loan Default