Featured Article - Decoding Student Lending
Decode Student Lending
Credit unions should look beyond the headlines to fully understand the current environment.
Written by Jim Holt, Credit Union Student Choice
Over the last year, media outlets have provided ample coverage of America’s ever-increasing student loan debt ─ and for good reason. With skyrocketing college costs and ongoing economic turmoil, millions of students and parents face significant financial challenges as a result of student borrowing. Whether news coverage is spurred by the release of government data or by bankruptcy lawyers and collection agencies trying to capitalize on a perceived crisis, there is little doubt that student lending and college affordability are under the microscope. What does this all mean for credit unions currently engaged in private student lending or thinking about offering a private student lending product?
Deciphering The Debt
Between 1982 and 2008, median family income rose 147%. Over the same time period college tuition and housing costs rose an astounding 439%, according to the Center for Economic and Policy Research. Not surprisingly, student loan debt has risen in lockstep with soaring education costs, surging college enrollment, and free-flowing federal student loans. According to a recent report from the Federal Reserve Bank of New York, of the 241 million people in the United States who have a credit report with Equifax, about 15.4% or 37 million hold outstanding student loan debt totaling $870 billion. While that is a significant number, breaking it down reveals some interesting facts:
The median balance is $12,800
72% of borrowers have less than $25,000 in debt
Only about 5% of borrowers owe more than $75,000
Compare these numbers with research from The College Board that indicates a typical bachelor’s degree recipient can expect to earn about 66% more during a 40-year working life than the typical high school graduate. This data makes it clear that a college education is still a tremendously worthwhile investment for young adults, especially if they are planning carefully and borrowing wisely.
Another key takeaway is that approximately 85% of outstanding debt is in the form of federal student loans. When headlines warn about rising student loan defaults, it’s important to understand that most often the loans being referenced are federal student loans. Historically, many federal student loans were originated by private lenders through the now-defunct Federal Family Education Loan Program (FFELP).
However, these loans are now originated directly by the federal government. While these loans are the most consumer-friendly and should always be maximized by students, they are the most challenged from a risk perspective. They carry no traditional underwriting criteria, require no co-borrower or credit score, and are readily available to almost all students, regardless of the school being attended.
When evaluating risk, the type of school being attended is also critically important. According to a recent article on CNN Money, the rise in student loan defaults was particularly driven by for-profit colleges, which commonly have default rates of up to 15%. This trend has prompted new federal rules, whereby schools with excessive default rates can lose eligibility for the federal loan program. An editorial in The New York Times also pointed out that individuals attending for-profit colleges make up nearly 50% of total defaults, through they represent only 11% of the higher education student body.
Best Practices In Private Lending
While comprising only about 15% of outstanding student loan debt, private student loans often come under fire from consumer advocates due to questionable lending practices and exorbitant rates and fees. This criticism is not without merit. Private student loans grew rapidly from the year 2000 on as college costs soared and lenders cashed in by selling loans into the secondary market. Transparency, borrower value, and lending risk frequently took a backseat to investor demands.
Credit unions, however, function on a completely different model and thus have a unique opportunity to be part of the solution in this market. By leveraging their balance-sheet lending capability and incorporating best practices, credit unions can craft a program that delivers a superior product to members, mitigates risk, and returns positive value to the cooperative.
Education: Prospective borrowers must understand that private student loans should only be used to fill educational funding gaps after lower-cost sources of funding like grants, scholarships, and federal Stafford loans have been exhausted.
Underwriting: Sensible underwriting criteria will factor in credit score and history, and encourages the use of a co-borrower.
Certification: School certification should be conducted to verify enrollment, validate the loan amount, and determine fund disbursement.
School Quality: Loans should be restricted to students who are attending traditional 4-year, not-for-profit schools with a proven history of low student loan defaults.
Relationships: Credit unions should lend to students and families within their existing field of membership to establish an opportunity for genuine, long-term relationships.
College costs are not going down and the need for fair-value education financing is more important than ever. By focusing on the important details that exist behind the headlines, credit unions can play an important role in helping members and redefining the value of private student lending.
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