What's Missing In Much of the Student Loan 'Analysis'
Readers beware. On the heels of the Consumer Financial Protection Bureau/Department of Education report, "Private Student Loans," sensational headlines continue.
While private student loans (PSLs) make up just a small fraction of the overall student lending market (less than 7% of total originations during 2010-11), abusive lending practices during the boom years of 2005-08 make for dramatic stories. In the early 2000s, skyrocketing tuition and soaring enrollment fueled the fire as free-flowing capital from the asset-backed securities market made it easy for aggressive lenders to step in. And they did, focusing on quantity over quality, with little concern for risk management or borrower education. Loans were abundant, and underwriting standards were shallow. In hindsight, the boom - and ultimate bust - of private student lending is no surprise.
Real Insights Are Buried
But the more significant content of the report is buried under the headlines: its analysis of the current marketplace (vastly different than the mid 2000s) and several recommendations to improve upon the PSL processes of the past. And, that's where credit unions are ahead of the game. Our industry has always done things differently, largely distinguishing it from the misguided lending practices noted.
Many of the recommendations presented in the report are already in place at credit unions that offer private student lending programs. Early on, responsible credit unions established quality lending standards and guidelines, positioning themselves as valuable resources for students and families looking for help to fund college costs. As a result, these programs have become a popular product offering among credit unions.
For lenders participating in private student lending, key considerations include:
* School certification of PSLs. This is one of the CFPB/DOE report's recommendations, and we (along with almost all credit unions we're aware of) agree fully. School certification is critical for limiting debt and making sure that borrowers take advantage of other lower-cost sources of aid before turning to a private student loan. Reputable student loan programs work with a school's financial aid office to validate the borrower's enrollment, verify that the loan amount doesn't exceed the student's cost of attendance, and distribute funds directly to the school, not the student.
In the past, effort was placed on driving up loan balances to maximize profitability. By inviting the school financial aid office into the process, credit unions can build a healthy portfolio while ensuring that students are not drowning in unnecessary debt.
* Using a co-signer. Research clearly shows that co-signed student loans perform significantly better than non-cosigned loans. In fact, default levels for non-cosigned loans can be double that of cosigned loans. And, given the economy is still slow in its recovery, injecting this co-signed support is smart business.
* Education for borrowers. The CFBP/DOE report suggests-and we certainly agree-that lenders must provide clear information to borrowers so that they fully understand their debt obligations. As reported by the CFPB, too many students fail to take advantage of their federal aid eligibility. Credit unions must educate consumers on the importance of exhausting all lower-cost funding options - including free money through grants and scholarships, as well as federal student loans - before turning to private lending sources.
Type of School Is Important
* Loan performance based on school type. The type of school a student attends clearly affects his or her ability to repay. An Inside Higher Ed article reports the most dramatic spike in loan defaults occurred at for-profit schools. In 2008, these students accounted for just 12% of all undergraduates and nearly 28% of the borrowers entering the repayment cycle for their federal loans. However, they represented 47% of borrowers defaulting on federal loans within two years of entering repayment.
The DOE cites similar results with private-lending programs for non-traditional schools. These factors make lending responsibly based on school type an extremely important consideration for PSLs.
Data available for consumer decision-making and lender underwriting. The report also notes that lack of data affects both consumers and lenders. Students have little information to guide them on what is an appropriate level of debt based on their area of study, and lenders have limited knowledge to assist in developing underwriting criteria. Additional data, if properly gathered and distributed, could be very helpful to families and student lenders--a role CUs can fill.
Four Central Lessons
I believe there are four central lessons we can take from the report: 1) private student lending practices of the mid-2000s were largely misguided and must not be repeated; 2) college costs and student enrollment will continue to climb, intensifying the need for affordable financial assistance to fill the funding gap; 3) underwriting must be rooted in sound and proven principles, not focused on generating loan volume, and 4) opportunities abound for credit unions to continue to meet the need for responsible, member-based, competitive student loan programs.
Lenders are in the business of risk management-not risk avoidance. The CFPB report clearly casts a bright light on past transgressions while making a strong case for lending success if done properly. Our schools are in the business of educating and preparing students to become strong, contributing members of society. By synching these ambitions under a not-for-profit mentality, we can find a sustainable solution.
Jon Jeffreys is President of CU Student Choice, a CUSO that positions credit unions as leaders in education financing. For info: http://www.studentchoice.org/.