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If you're not a recent graduate, the parent of a recent graduate or someone who pays really close attention, you may not be aware of how much the student-loan game has changed.
You may know that college costs continue to rise and loans have pretty much replaced grants in financial-aid packages.
But you may not realize how aggressively these loans are peddled to teenage and young adult borrowers; how tough it is to get rid of this debt once it's accrued; and how very, very profitable the whole game has become for many private companies.
So profitable, in fact, that:
- Federal and state regulators are investigating allegations of kickbacks and conflicts of interest in college financial aid offices. Several schools have admitted that lenders showered their financial-aid officials with gifts, consulting fees and stock options in return for being added to the colleges' all-important "preferred lender" list, which determines where most students get their loans. Several lenders have agreed to new guidelines to curb the questionable practices.
- Consumer advocates complain that some lenders mislead students into opting for more-expensive private loans when the borrowers are eligible for lower-rate federal loans. A 2003 study (.pdf file) by the U.S. Public Interest Research Group found half of private-loan borrowers failed to exhaust federal loan sources before turning to private borrowers, and 24% received no federal loans at all.
- As the amount of student-loan debt soars, borrowers are learning to their chagrin that lenders have blocked off the exits. In 1998, Congress made federal student loans all but impossible to discharge in bankruptcy. In 2005, lenders persuaded lawmakers to make private loans just as difficult to shake -- even though there are no government guarantees or taxpayer subsidies involved and the lenders' rates are based on the risk involved in making the loans.
There are three basic types of loan programs for undergraduate students: direct loans made by the federal government; federal loans made through private lenders but subsidized and guaranteed by the federal government; and private loans made by private lenders, with no federal guarantees or taxpayer subsidies.
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The total amount undergraduates can borrow from the first two categories, direct loans and federal loans made through private lenders, has been frozen since -- get this -- 1992. (To understand how very long ago that was: It was the year Whitney Houston's "I Will Always Love You" topped the charts.) Meanwhile, average college costs have more than doubled. So students increasingly have turned to private lenders to pay their bills.
And by increasingly, I mean shockingly so: Amounts borrowed from private lenders soared 1,201% between the 1995-96 academic year and 2005-2006, according to the College Board, from $1.3 billion to $17.3 billion. The amount tripled in the past five years alone.
Private loans can be a worthwhile investment when they help students pay for educations that will enhance their lifetime earning potential. But because there are few limits, such loans also can be used by naïve students to pile up mounds of debts for careers that won't pay off. I've heard from more than a few recent graduates with six-figure debts who received liberal-arts degrees that qualified them for jobs that earn less than $50,000 a year.
When borrowers can't pay, lenders can get aggressive. Sallie Mae, the largest student lender, has transformed itself into the country's largest collection agency as well. If private lenders can't get borrowers to pay, federal student loans can be turned over to the U.S. Department of Education, which has extraordinary powers to seize tax refunds, garnishee wages and pursue other collection paths typically closed to private lenders.
Continued: What the critics say
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