Since July 2007, more than 180 education lenders have suspended participation in federal education loan programs and more than 45 lenders have suspended private student loan programs. There have also been 6,500 layoffs industry-wide. Millions of borrowers have been affected.
The impact on students and their families is focused in three main areas: availability, eligibility and cost.
Availability
While many lenders have left the federal student loan marketplace, eligible borrowers should still be able to obtain federal education loans. Congress helped avert a crisis in the federally-guaranteed student loan program by passing the Ensuring Continued Access to Student Loans Act of 2008 (ECASLA). This legislation allowed the US Department of Education to provide capital to education lenders – at no net cost to the federal government – so that they could continue making federal Stafford and PLUS loans. Several hundred colleges switched into the Direct Loan program to avoid the turmoil associated with lenders dropping out of the student loan programs. Consolidation loans also remain available to borrowers through the Federal Direct Loan Consolidation program at loanconsolidation.ed.gov even if their loans were not originated in the Direct Loan program.
The ECASLA legislation also increased the loan limits for unsubsidized Stafford loans. The annual loan limits increased by $2,000 per year and the aggregate loan limits increased by $8,000 for dependent undergraduate students and $11,500 for independent undergraduate students. In addition, parents can now defer Parent PLUS loans while the student is in school and for six months after graduation.
While some of the smaller lenders are still exiting the federal education loan programs due to tight margins, the ECASLA liquidity provisions appear to have stabilized the federally-guaranteed student loan program.
Private student loans, on the other hand, continue to suffer from availability issues. Three-quarters of the lenders offering private student loans, representing about a third of the private student loan volume, have suspended their private student loan programs. The remaining lenders are still liquidity constrained, and have reacted by tightening their credit underwriting standards and increasing interest rates.
- In early 2007, borrowers could obtain traditional private student loans with credit scores as low as 620 and non-traditional private student loans with credit scores as low as 520.
- Today, all of the non-traditional private student loan programs have evaporated and traditional private student loan programs are requiring credit scores of at least 650 and in many cases over 700. Even borrowers with credit scores over 750 are finding it more difficult to obtain private student loans.
- Students enrolled at foreign medical schools are also experiencing a reduction in the availability of private student loans.
Eligibility
The Federal Stafford loan is not affected by eligibility issues because it does not depend on the borrower’s credit history.
The Federal PLUS loan, on the other hand, requires the borrower to not have an adverse credit history. An adverse credit history is defined as having had a foreclosure, repossession, tax lien, wage garnishment, default determination or bankruptcy discharge within the last five years or a current delinquency on any debt of 90 or more days. To the extent that the subprime mortgage credit crisis was precipitated by an increase in foreclosure rates, there has been an increase in PLUS loan denial rates.
- Dependent undergraduate students whose parents have been denied a Parent PLUS loan are eligible for increased unsubsidized Stafford loan limits, an extra $4,000 a year during the freshman and sophomore years and an extra $5,000 a year during the junior and senior years.
- Graduate and professional students who have been denied a Grad PLUS loan are not eligible for increased unsubsidized Stafford loan limits. However, loan volume statistics demonstrate steady growth in Grad PLUS loan volume, compared with significant year-over-year declines in Parent PLUS loan volume, suggesting that PLUS loan denials are less of a problem for graduate and professional students than for parents.
As noted previously, lenders have adopted more stringent credit underwriting criteria for private student loans. Not only are the lenders requiring higher credit scores of borrowers and cosigners, but more borrowers are being required to have a cosigner. Also, even borrowers or cosigners who have good credit scores are being denied because of secondary criteria such as volatile income or self-employment. About a third of borrowers who might have qualified for private student loans in early 2007 are now finding their applications rejected.
Cost
Lenders cannot control interest rates and fees on federal education loans, since the maximum rates and fees are set by law. They can, however, increase costs to the extent that they were previously offering discounts on those rates and fees. The majority of lenders have eliminated all back-end discounts except a 0.25% interest rate reduction for auto-debit. This is partly because profit margins have narrowed considerably and partly because any lender who intends to sell their loans to the US Department of Education through ECASLA cannot offer better discounts than those offered by the Department. After all, it is the lender that holds the loan during repayment that pays for the back-end discounts, not the lender who originates the loan.
However, Congress passed a phased-in interest rate reduction on the subsidized Stafford loan for undergraduate students as part of the College Cost Reduction and Access Act of 2007. The interest rate dropped to 6.0% in 2008-09 and 5.6% in 2009-10, and will be dropping to 4.5% in 2010-11 and 3.4% in 2011-12, and then back to 6.8% in 2012-13. The interest rates on subsidized Stafford loans for graduate and professional students and on all unsubsidized Stafford loans remain at 6.8%.
Lenders do have pricing power on private student loans and have been passing on their increased cost of funds by increasing the interest rates and fees on new loans. Private student loans typically consist of a variable rate index, such as the Prime Lending Rate or the 1-month LIBOR index, plus a fixed rate margin. (The fixed rate margins are typically offered in four to six tiers that depend on the borrower’s credit score. There may also be a separate set of tiers for borrowers with and without cosigners.) Lenders have increased the margins on their loans by 2% to 4% since the start of the credit crisis. The variable rate indexes have decreased at the same time, yielding an overall average interest rate that is only about 1% higher than in early 2007. However, borrowers need to be concerned not just about the current “teaser” rates on the loans, but how high those rates may increase over the life of the loan. If the LIBOR index can drop by 3% in twelve months, it can just as easily jump by 3% in a year. So a variable rate on a private student loan that is currently competitive with the fixed rate on the PLUS loan may ultimately be much more expensive over the 20 or 25 year life of the loan. Index rates will start increasing soon after the end of the credit crisis. Borrowers with excellent credit who are enticed by current low interest rates should realize that those rates may increase a lot just a few years from now.
What’s Next?
There are already some signs of the start of a recovery in the capital markets. Several lenders have succeeded in securitizing private student loans for the first time since 2007. Lenders have also made modifications in their private student loan programs to make it easier for them to be securitized. For example, Sallie Mae replaced its Signature Student Loan with a new Smart Option private student loan. The Smart Option loan requires borrowers to make interest only payments during the in-school and grace periods. Not only does this avoid negative amortization and helps borrowers repay the debt sooner, but the improved cash flow and likely decrease in defaults will make it easier for the lender to raise capital for the loans.
Unemployment rates will likely peak in late 2009 or early 2010. At that time there should be an increase in the momentum of student loan securitizations in the capital markets, making it easier for lenders to raise funds for education loans. This should lead to an easing of the availability and eligibility restrictions that have affected private student loans, and may also lead to a decrease in the cost of the loans.
In the meantime, President Obama’s budget proposals for an expansion and reengineering of the Perkins Loan program, if enacted, will provide $4.9 billion in additional Perkins loan volume per year. This will shift some borrowing from private student loans to federal loans, especially among students who are no longer able to obtain private student loans.
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