A Shaky Season for Student Loans

Subprime woes and recent legislation have lenders tightening standards for applicants, and the credit crunch is eating away at other sources for tuition money

Shortly after New Year's Day, Pat Watkins, financial aid director at Eckerd College in St. Petersburg, Fla., placed a worried call to National Education, a student loan company she has been working with for nearly two decades. She had heard rumors that the company was no longer funding federal Stafford and PLUS (Parent Loans for Undergraduate Students) education loans, but had received no official word from the company.

She found out that the phone of National Education's local rep had been disconnected. Later she learned that Chicago-based National Education was not planning to accept applications for new loans for the spring semester after Jan. 15, though they planned to fund disbursements for students who received loans for the fall.

Federal Loans Lose Funders

That was the first surprise. In mid-January, Watkins received a letter from Phoenix loan company NextStudent saying they, too, would not be funding new Stafford or PLUS loans for the spring semester, only funding loans where there has been a fall disbursement.

At least one other student loan company, San Diego-based Goal Financial, has also pulled back their federal loan lending, according to college loan officials. Federal student loans are low-interest loans guaranteed by the federal government. Congress outsources many of these loans to private companies and has recently passed legislation that has eliminated many of the subsidies they gave these lenders to encourage them to participate and administer the federal loans.

"I haven't seen it this bad before," said Watkins, who has worked in the financial aid industry for 34 years. "It is going to put a lot of students in a bind." She said she will help students find a new loan provider, but for students with existing loans this will likely incur more costs and a second loan to be repaid.

Student financial aid season—which started on Jan. 1—is getting off to a shaky start. The industry is experiencing jitters as the fallout from the subprime credit crisis trickles down to lenders who make private loans, as well as companies that also issue federal loans. For the moment, the credit mess has had a limited effect on student borrowers, but experts said they expect students to be affected in the next few months.

Tougher Standards

For instance, students with poor or only decent credit ratings—those with FICO credits scores under 650—may encounter difficulty obtaining a private loan with reasonable interest rates or, for that matter, obtaining one at all. Loan companies may refuse, in some cases, to make loans to students at schools that have high default rates, financial aid directors said. And families that have relied on home equity borrowing to pay college costs may turn to private lenders as the home equity market tightens up (BusinessWeek, 1/16/08).

Students also may need to change their loan application tactics. In the past, students who were authorized account holders on their parents' credit cards could get loans with interest rates based on their parents' credit rating. They now will be required in most cases to apply for such loans with their parents as co-signers. Those applying for federal loans may also find their options more limited, as many major loan companies that work with the federal government temporarily pull out of the federal student loan program.

While the subprime crisis has created the most news, student lenders are also facing fallout from legislation passed by Congress last fall that eliminated nearly $19 billion worth of federal subsidies to student lenders. The combination of these two developments has made for a challenging financial environment for student loan operators, says Mark Kantrowitz, publisher of FinAid, an online provider of student aid information. "The joke in the industry is that Congress took away half the profits, and the asset-based securities markets took away the other half," Kantrowitz says.

The $85-billion student loan industry is often criticized because of the large profits private students lenders make off of students by charging them high interest and origination fees. The legislation was propelled by student borrowers who wanted to see the subsidies issued to private lenders channeled back to federal student loans. As a result of the legislation, an additional $11 billion in federal aid is now available to students.

Financial aid officers are predicting that student loan applicants may find the process more daunting and complicated than in years past. As with the mortgage market, many private student loans are packaged and sold to investors as asset-based securities, leaving them vulnerable to aftershocks of the subprime credit crisis. For example, FinAid's Kantrowitz predicts that many companies will no longer issue loans to students with credit scores below 650 to protect themselves from any subprime exposure. In addition, loan companies will require more applicants to have co-signers. "I do expect it to be a little more difficult to get one of these private loans," Kantrowitz says.

Are Lenders Hurting?

Borrowers' worries extend even to the largest student loan lender, SallieMae (SLM), which is also cutting back on federal loans and concentrating more on the private market. Earlier this month, the company said in a Securities & Exchange Commission filing that in response to the financial environment, it would be "more selective" in making federal and private education loans. Since then the company has reassured institutional borrowers that it is in sound financial condition, according to a Jan. 17 report in the Chronicle of Higher Education.

The decision by some companies to withdraw from the federal loan program could indicate that more lenders are hurting, said John Dean, special counsel to the Consumer Bankers Assn., an Arlington (Va.) group that represents bank lenders in the student loan programs. "This is significant because National Education and Goal Financial were well-known operations and were seen a couple of years ago as growing rapidly," Dean says. "We presume that if they are experiencing difficulty that others could be experiencing difficulty as well."

Representatives from National Education and Goal Financial declined to comment on the federal loan suspensions. Next Student did not return phone calls requesting comment.

Private loan companies' investment practices may have led to some "overexuberance" on the part of private lenders, says Robert Shireman, executive director of the Project on Student Debt, a group that focuses on student financial aid. Like Kantrowitz, he expects private loan companies to be more cautious when making loans to students.

Battered Family Finances

In the meantime, financial aid officers are sitting back and anxiously waiting to see how the student lender landscape will shift if more loan companies continue to pull out of segments of the market.

Bill Witbrodt, director of student financial aid services at Washington University in St. Louis, says he has not seen students directly affected yet, but expects that could change. Plus, battered family finances could send more students into aid offices. Right now, students aren't reporting family financial stress from the credit crisis, Witbrodt says. "If this continues, I would expect it [to] and, in fact, I'm surprised it hasn't already."

Students facing the greatest difficulty in obtaining private loans are international graduate students, who are not eligible for any of the federal loan programs, says Rockne Bergman, manager of graduate and professional programs at University of Minnesota's financial aid office. He counsels international students seeking loans from the law, business, and nursing schools, among others, and says he has already seen the market tighten for them.

"These lenders are just being very careful as to whom they are lending to. And they want to make sure they will be able to get those loans paid back," Bergman says.

Financial aid officers like Eckerd College's Watkins say their greatest fear is that the lending environment will create a situation where students strapped for cash will take out risky private loans with sky-high interest rates, no matter what the cost. For example, Watkins says she has seen commercials on TV aimed at students with poor credit ratings and promising no interest or payment until graduation. Those loans tend to come with higher origination fees and higher, unpredictable interest rates that compound the amount students owe after graduation into a "significantly higher amount," Watkins says: "We haven't seen the full impact of this yet, but it is coming."

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