The College Loan Credit Crunch: What You Need to Know

You've seen the headlines: "College loan meltdown" or "student loan credit crunch.” It's enough to make any parent and high school senior nervous. What on earth is going on and is this a big worry?

As with anything, it is important to look beyond the sensationalist, attention and reader grabbing headlines to the facts. So is there a crunch in college loans? The ambiguous answer is yes and no.

• Yes - if it will be necessary to take out private college loans to pay for a college education.
• No (currently) - if your student will be paying for college though a combination of money from mom and dad, college savings, 529 savings plans, scholarships, federal financial aid (loans or grants), and state financial aid.

The "currently" caveat is there to show that should credit problems get worse, then other forms of aid may be impacted. Funds may be tight for state run college aid programs. For example, earlier this year the Massachusetts Education Finance Authority (MEFA) saw some difficulty in raising the $600 million it needed for loans for the upcoming 2008 school year.  On April 15, 2008, MEFA had to take the unprecedented step of suspending all Federal education loans effective July 1, 2008. In addition, MEFA is no longer accepting any new Federal Consolidation applications. MEFA will, however, still be able to provide private education loans.

The Problem is in Private College Loans

For the time being, it is private college loans that are being impacted by the credit problems. Private college loans are those loans that a student/parent obtains to make up the difference between all other forms of payment and the cost of tuition. Private college loans also tend to be the most expensive loans from the standpoint of fees and interest rates.

Why the tightness? Financial institutions who got burned making questionable housing loans are now becoming more cautious with their college lending. The reasons behind this are lack of capital (money to lend) and the declining profitability of college loans. Some lenders are stopping their college lending altogether, but most are simply changing the requirements for the loans. The most common restrictions cited are:

• Tightening the credit requirements for obtaining a loan. This makes it difficult or impossible for a student with poor credit to obtain a private college loan. This can be mitigated if the student's parents will cosign for the loan. A cautionary warning to parents: if junior later defaults on that loan it is the parents whose credit rating gets hit, and the parents who are on the hook for payment.
• Excluding schools with poor graduation rates. Lenders may also take into account the graduation rate of an educational institution and not make loans for students who wish to attend schools with poor graduation rates.

This problem in availability of private college loans tends to be less of an obstacle for the first-time student and more of a problem for an individual already in the work force looking to obtain or further their education. This also tends to impact students looking to attend career or for-profit colleges more because of their relatively high costs and lower graduation rates - which is why you hear officials from these type of institutions making the most "noise" about student loan credit problems.