There have been numerous media reports, along with considerable confusion, surrounding the subject of student loans. There are major differences, for instance, between federally guaranteed loans and private student loans. Both loans, though, play complementary and vital roles in financing higher education for students.
Federal loans are needs based and are provided — with few exceptions — to most students who apply for them. They cover about one-fourth of the cost of higher education and are guaranteed by the federal government.
Private student loans, on the other hand, have rigorous underwriting standards and most require a co-signer — typically parents or guardians. During the last four academic years, 90% of undergraduate and 75% of graduate private loans had co-signers, an indicator of significantly lower default rates, according to MeasureOne, a San Francisco research firm that tracks student loan data.
In the case of federal loans, the government's "one-size-fits all" approach has led to higher-than-average delinquencies and defaults. Every applicant pays the same interest rate and few are turned away, regardless of credit history.
Default Rate Raises Brows
The three-year federal loan default rate for 2010 averaged 14.7% across all U.S. states and territories, according to the U.S. Department of Education. The default rates, calculated in July 2013, ranged from a low of 6% in North Dakota to a high of 23.1% in Puerto Rico.
Even though the federal loans' default rates are concerning, they do not threaten the financial system as did mortgage backed securities in 2008 and 2009. Federal loans have an estimated balance of $1.2 trillion and are guaranteed by the U.S. government, while mortgage debt is estimated at $8 trillion and has no such guarantees. They also carry some borrower friendly features like income based repayment plans and loan forgiveness programs.
By comparison, financial institutions that serve large academic populations and have a history of offering private loans report average default rates of just 3%, such is the strength of the institutions' loan underwriting standards and its stewardship of the loans. As of third-quarter 2012, only 3.89% of private loans were seriously delinquent; by third-quarter 2013 that number had dropped to 3%, according to MeasureOne.
Private loans offer a good return on assets. Most financial institutions realize an ROA of 300 to 400 basis points from their private student loan portfolios. In the current low-interest rate and declining margin environment, these assets are a welcome addition to loan portfolios seeking diversification and higher yields.
There are reasons beyond the financial benefit for offering private loans. As self-help and educational institutions, there are few better financial products for credit unions to offer their members than loans for their children's educations. Higher education, however, is becoming costly for many American families and can no longer be covered solely by federal loans.
Since 1978, the cost of going to college has spiked 1,120%, almost twice the cost of health care and more than four times the consumer price index increases for that same period. This included a 31% increase from 2002 to 2008 and 24% more between 2008 and 2013, according to
Relationship-Building Tool
Private loans can be an entrée to forming a lifelong relationship with young adults and their parents. Young students favor an automated approach to borrowing, which most financial institutions and third-party back-office support providers offer. Once the loan has been granted and the relationship forged with the young consumer, the door is open for providing other loans in the future.
Speaking of parents, private loans offer the chance to develop relationships with the loans' co-signers. Few private loans leave the financial institution without the involvement of a parental co-signer. The loan can help increase share of wallet with consumers who already use the institution and new relationships with first-time borrowers.
By offering an in-school payment option, lenders can improve the performance of these loans by teaching good repayment habits early while allowing the borrower to build a positive trade line on their credit bureaus.
In addition to basic student loans, CUs should also consider consolidation loans that aggregate a series of loans into a single, more affordable payment. Large amounts of student loan debt have forced young consumers to postpone major consumer purchases, such as cars and houses. Heavy student loan debt can delay major milestones, such as marriage and children, while borrowers attempt to repay the money they owe for their education.
Consolidation loans as part of a student loan program can be profitable loan products, as well as pave the way for Generation Y and other young borrowers to move on with their lives and the associated big-ticket purchases that characterize various life phases. Helping young borrowers finance their education ultimately will be appreciated, and can lead to ongoing relationships and future loans from the institution.
Finally, both private and federal loans are investments in the nation's growth. Despite occasional challenges, student loans of all types are investments in a better educated population. An educated citizenry helps to promote and strengthen a middle class, a segment of the U.S. population that has been tested recently.
Understanding Private Student Loans, a LendKey white paper, is available gratis at
Vince Passione is CEO and founder of LendKey Technologies Inc., New York. He can be reached at
