CFPB: Many students & parents are unaware of private student loan pitfalls
A study by the Consumer Financial Protection Bureau found that students and their parents often don’t understand the basic differences between federal and private student loans when making important decisions on college financing.
The report identified three key pitfalls of private student loans:
Private student loans often carry variable interest rates that could result in significantly higher costs and monthly payments.
As of Dec. 31, 2011, the variable rates offered by private lenders range from 2.98% to 3.55% for borrowers with exceptionally good credit to 9.5% to 19% for those with bad credit history. The average variable interest rate reported was 7.8% – more than doubled the federally-subsidized Stafford loan rate of 3.4%.
“These are initial rates in a very low rate environment and could increase substantially if interest rates rise generally,” the CFPB pointed out.
So if a prospective college freshman and his parents sign up for a private loan with the average 7.8% variable rate today, it’s all but a sure bet that the interest rate will balloon – even reaching double digits – by the time he graduates from college.
The CFPB also noted that even if borrowers qualify for fixed rate loans, the interest rates offered by many private lenders are well above the federally-subsidized Stafford loan, ranging from 3.4% to 13.99% depending on the borrowers’ credit standing.
Private student loans typically offer fewer repayment options for borrowers who have difficulty meeting their monthly loan payments but want to avoid delinquency or default.
The CFPB estimated that students who graduated in 2009 faced unemployment rates of 16% as the job market struggles to recover from the worst recession since the Great Depression, and many recent graduates are experiencing a hard time paying back their student loans. Unlike federal student loans, private loans do not offer deferment (which allows a borrower to postpone loan payments without accruing interest) and most lenders won’t modify monthly payments based on the borrower’s income.
Although some lenders do grant loan forbearance to enable struggling borrowers to temporarily stop making payments for up to 12 months, the CFPB study found that fewer lenders are making such accommodations following the 2008 financial crisis, noting the rate of outstanding loans in forbearance dropped from 17.1% in 2007 to 3% in 2011. And unlike home mortgages, student loan borrowers don’t really have the option to refinance their loans to reduce their interest rate or monthly payments.
“Private loan borrowers experience challenges when attempting to restructure their loans,” said Rohit Chopra, Consumer Financial Protection Bureau’s Student Loan Ombudsman. “We see that many borrowers feel stuck with high monthly payments because they cannot easily refinance.”
As young professionals devote a larger share of their income to repaying their high-interests student loans, they have less money to invest in home ownership and save for their retirement.
“First-time homebuyers are an important source of demand, and data reveals that adults in prime home-buying age cohorts are living at home with their parents and seeing reductions in their homeownership rates. In addition to home ownership, data also reveals low participation and contribution rates to employer retirement plans among young graduates, which can challenge their future retirement security,” said Chopra.
With fewer payment options available, borrowers experiencing serious financial hardship face default if their payments are 120 days past due. A default record will hurt the students’ (and their co-signers’) access to credit in the long-run, severely limiting their abilities to secure loans to buy cars or homes even after they’ve found gainful employment.
Private student loans are increasingly marketed directly to students and their parents, leading to over-borrowing.
Without schools certifying the actual amount of tuition and fees required for attendance, the CFPB study found that some private student loan amounts have exceeded 175% of tuition and that 40% of private loan borrowers did not fully take advantage of their low-interest federal Stafford loans.
“Students borrowed materially more, relative to the core cost of school, without any reduction in other sources of aid,” according to the CFPB. “Over-borrowing increases the likelihood of default to the detriment of both borrower and lender.”
- Consumer Financial Protection Bureau: Private Student Loans Report – July 2012
- Consumer Financial Protection Bureau: Falling behind on your student loan payments?
- WhatTheFolly.com: Transcript: Testimony of CFPB Student Loan Ombudsman Rohit Chopra before Senate Banking Committee
- WhatTheFolly.com: Transcript: Sen. Sherrod Brown on private student loans
- WhatTheFolly.com: Transcript: Sen. Bob Corker on private student loans
- WhatTheFolly.com: Federal judge reverses college ‘gainful employment’ rule
- WhatTheFolly.com: College loan rate hike averted
- WhatTheFolly.com: Student loan delinquency rate climbs above 20%
Category: Advocacy, Analysis, Banking & Finance, Consumer, Current Events, Economy, Government, News, U.S. · Tags: borrowers, college students, Consumer Financial Protection Bureau, consumer protection, credit history, credit rating, default, defaults, deferment, employment, forbearance, Gainful Employment Rule, higher education, income, interest rate, jobs, private loans, recent college graduates, Rohit Chopra, Stafford loans, student debt, student loan defaults, student loans, taxpayer-subsidized, tuition, unemployment, universities