Study: Private student loans parallel subprime

[July 20, 2012]  WASHINGTON (AP) -- Risky lending caused private student loan debt to balloon in the past decade, leaving many Americans struggling to pay off loans that they can't afford, a government study says.

Private lenders gave out money without considering whether borrowers would repay, then bundled and resold the loans to investors to avoid losing money when students defaulted, according to the study, which is being released Friday.

Those practices are closely associated with subprime mortgage lending, which inflated the housing bubble and helped bring about the 2008 financial crisis.

"Subprime-style lending went to college, and now students are paying the price," said Education Secretary Arne Duncan, whose department produced the report with the Consumer Financial Protection Bureau.

Duncan said the government must do more to ensure that people who received private loans enjoy the same protections as those who borrow from the federal government.

Student loans fall into two main categories: Loans directly from the government and those offered by banks and other private financial companies. The report focused on private student loans, which spiked from $5 billion in loans originated in 2001 to more than $20 billion in 2008. After the financial crisis, as lending standards tightened, the market shrank to $6 billion in 2011.

American consumers still owe more than $150 billion in private student loan debt, the study said. Including federal loans, Americans now owe more than $1 trillion in student loan debt, according to the CFPB. It has surpassed credit card debt as the biggest source of unsecured debt for U.S. consumers.

Private student loans are riskier than federal loans, the study said. They often carry variable interest rates, which can cause monthly payments to rise unexpectedly. Federal loans offer fixed interest rates.

In many cases, if a borrower is unable to repay, federal loans can be postponed or reduced. Those options are rare for private loans, the study said.

Students often did not understand the difference between federal and private loans, the study said. That caused many to take out costly student loans when they were eligible for cheaper, safer government loans.

The study highlights a unique feature of student debt: Unlike other credit card balances and most other debt, it is nearly impossible to cancel student debt by filing for bankruptcy. That leaves many borrowers trapped, behind on loans that lenders are unwilling to modify, the study said. There are more than 850,000 private loans in default, worth more than $8.1 billion, it said.

"Too many student loan borrowers are struggling to pay off private student loans that they did not understand and cannot afford," said Richard Cordray, director of the Consumer Financial Protection Bureau. The CFPB was created in the wake of the financial crisis to protect people against unfair loans, unexpected fees and other financial threats.

Lending standards for private student loans were loose during the credit bubble of the mid-2000s, the report said. Because private lenders marketed directly to students, bypassing school financial aid officers, schools did not review borrowers' financial needs or enrollment status. As a result, many borrowed far more than they needed to pay for tuition. The loans went to people with increasingly weak credit scores, making repayment less likely, the study said.

The report is based on data from nine lenders on over more than 5 million loans made between 2005 and 2011, as well as data from five nonprofit lenders. It was required under a sweeping overhaul of financial rules passed by Congress in 2010.

It said that lenders have been more careful since the financial crisis reduced the amount of credit available. For example, in 2011, more than 90 percent of private student loans required a co-signer, compared with 67 percent in 2008.

[Associated Press; By DANIEL WAGNER]

Daniel Wagner can be reached at http://twitter.com/wagnerreports.

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