Private Student Loans Defined
In the $200 billion a year higher education market, private student loans have carved out a significant piece of the pie, becoming a critical educational funding component for millions of American students and families. Private loans help fill the funding gap-the difference between the cost of attendance and the amount covered by federal aid and scholarships-faced by many of today's students. These loans are in the name of the student but often require a co-signer. They are not guaranteed or subsidized by the government and usually feature a variable interest rate that floats with a market index such as the Prime Rate or LIBOR. Interest rates are based on the student's credit score and/or the credit score of any co-signers they have on the loan. At Credit Union Student Choice we feel strongly that students should only resort to private loans when they have exhausted all "free" and "cheap" options, such as scholarships, grants, and federal student loans.
Explosive Growth
Fueled in large part by skyrocketing tuition costs and meager increases to federal student loan limits, the private student lending market has grown more than 350% in the last seven years alone, reaching $23 billion in 2007. With the total cost of attendance at both public and private schools increasing rapidly (6% increase in 2007), and many parents struggling with declining home values and a weakened economy, the private student lending market shows no signs of slowing down.
Historically, the private student lending market has been dominated by traditional lenders and specialty finance companies. These lenders typically fund new loans by selling existing loans as asset-backed securities in the secondary market - nearly 70% of private student loans entered this market in 2007. In early 2008, because of the mortgage meltdown and ensuing credit crunch, the market for securitized loans completely evaporated as investors were unwilling to buy asset-backed securities. This dramatic crash forced many lenders to exit the market as access to capital was severely restricted. With continued mortgage problems and a struggling economy, it could likely be several years before the secondary market once again becomes a viable option.
Questionable Quality
Referred to by some observers as the "wild west of lending", private student loans have a reputation for delivering poor economic value to borrowers. With little transparency in the industry, specific numbers are hard to find. Interest rates can vary greatly from one lender to another, but the "average" private student loan has a between 9% and 10%. On top of that, most lenders charged an origination fee which averaged between 4% and 5%, but in some cases was as high as 11%. 2008 has been marked by even higher rates and fees as the specialty finance companies that dominate private student lending struggle mightily due to the failure of secondary markets.
