By: Emily Bardales

Last Friday July 20, 2012, the Consumer Financial Protection Bureau and the Department of Education issued a report highlighting research results regarding private student loans.  The report acknowledges that the public does not have a strong understanding of the responsibilities attached to these loans, as evidenced by the fact that American consumers owe more than $150 billion in outstanding private student loan debt.  Unfortunately, it is unlikely that those impacted by this report will actually read it, as the report is 131 pages long.

Between 2005 and 2007 the United States experienced a lending boom, characterized by a period of growth and loosened standards for Private Student Loans (PSL).  But since approximately 2008, private lenders have tightened standards and increased loan requirements for students by requiring co-signers on the student loans to reduce the likelihood of default.

To explain the effects of the lending boom, the report begins by distinguishing the important differences between federal loans and PSLs.  Federal student loans, called Stafford Loans, offer more options for repayment than PSLs.  Stafford loans do not require the borrower to repay while in school and offer a six-month grace period after graduation before the student must start repaying the loan.  Further, once a student starts paying, the Stafford loans have a fixed interest rate and offer numerous adjustments for borrowers who have difficulty making payments.  There is a maximum amount that a student can receive fromStaffordloans, determined by an estimated calculation of what the cost of living will be while attending school.  It is often the case that these estimates are low, and do not account for unforeseeable expenses that can come up.  While there was recent talk of doubling these interest rates for undergraduates, an increase from 3.4 percent to 6.8 percent, this did not materialize.

As a consequence of the lending boom, the report points out that many students were and continue to take out PLSs without exhausting their Stafford loan eligibility. This has particularly significant consequences on borrowers, as the biggest difference between PLSs and federal loans is the interest rate.  The report states that the average PLS interest rate is 7.8% but could reach as high as 19%.  Additionally, PLSs are unforgiving; if a borrower misses a payment for 120 days then the borrower is placed in default with no way to eliminate that record of default.  So while private student loans appear comparable to federal loans while borrowers are in school and can be useful for students who have financial needs beyond that offered by federal Stafford Loans, the difference between them becomes apparent once the borrower is required to start making payments on the loan.

In addition to describing the history of the PSL explosion, the report makes various requests for Congress to address the student loan crisis.  The report calls on Congress to address consumer protection issues, enhance the role of schools in the private student loan process, and to require both institutions of higher education and lenders to work proactively to protect and inform borrowers.  While student loans will likely be a talking-point during the 2012 Presidential campaign, it is unlikely that we will see any of these potential changes until the next term.

Ultimately, the report hints that a solution to this high-risk borrowing could come with Congress passing laws permitting the discharge of private loans in bankruptcy, something that is currently not an option.  It is unlikely Congress would allow this for federal loans, since these come from taxpayer money; in contrast, private lenders make the decision to go into the business of loans in the same way credit card companies do.   Thus, it seems more justified to permit the discharge of private loans in the instance of bankruptcy.  On the other hand, students are likely as uneducated about filling for bankruptcy as they are about private student loans, and this potential solution could introduce a whole new set of problems for the economy and individuals with PSLs.