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College students heading off to campus in the fall will face a radically different student loan situation than they did just a year ago.
The credit crunch that rattled mortgage lenders has spread to the education lending market, with dramatic results. If the situation doesn't ease in coming months, student lending experts say, borrowers can expect:
- Higher loan costs.
- Fewer lenders, which could mean tens of thousands of college students scrambling at the last minute to find money.
- Tougher standards that could prevent some students from borrowing at all.
"It's a very different situation from last year," when lenders were falling over each other to compete for students' business, said Kevin Walker, the president and CEO of SimpleTuition.com, a student loan site. "And it's probably not clear to the consumer that this problem is looming."
Like mortgage lenders, student loan companies were criticized in recent years for loose standards that saddled many students with massive debts. Although student lenders didn't rush into the subprime market that eventually backfired with mortgages, they lavished loans on borrowers with little concern about their ability to repay. (Read "How did student loans get so sleazy?" for details.)
A perfect storm for student loans
The easy-money blitz for students has been threatened on a variety of fronts:Student loan defaults are up. The biggest student lender, Sallie Mae, reported a massive $1.6 billion loss last quarter, thanks in part to spiking default rates, and plans to set aside an additional $700 million to cover bad loans this year. Although the U.S. government guarantees lenders will be reimbursed for federal student loans, the bulk of Sallie Mae's losses were from private student loans, which aren't guaranteed.
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A key source of funds has dried up. As investors become increasingly spooked about the credit crunch and the rising risks that loans will go bad, they're avoiding buying bundles of loans, known as asset-backed securities, that are a major source of funding for some student lenders. This aversion applies even to federal student loans despite the government guarantee. Several recent auctions of federal student loan debt have failed, meaning that investors who hold the loans couldn't find any buyers. Without this critical source of funds, some lenders can't make loans.
Meanwhile, one state lending agency, the Michigan Higher Education Student Loan Authority, suspended its loan program, and Michigan's deputy treasurer predicted to The Wall Street Journal that other state agencies would soon face the same crunch.
"What's happening is investors are shy of everything" in credit markets, said Mark Kantrowitz, the founder of FinAid.org, an online guide to student financial aid. "Investors are overreacting."
Deborah Fox, who advises families on college funding strategies, predicts rates may climb as much as a percentage point as lenders struggle with the securities markets.
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"Variable rates that should be coming down in a low-interest-rate environment will be moving in the opposite direction," said Fox, of Fox College Funding, "which will put further pressure on the American consumer who is attempting to keep their head above water in what appears to be a recessionary environment."
Other sources of cash are more expensive. Not all lenders get their money from investment markets. Sallie Mae, for example, will tap a recently arranged $31 billion line of credit extended by Bank of America and JPMorgan Chase. But even lenders that don't rely on the asset-backed-securities market are paying more for the money because of the credit crunch, Kantrowitz said. Lenders will pass those costs along, he said, in higher fees and fewer discounts.
Continued: Lenders are cutting back
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