February 2008

Private student loans increasingly popular, but borrowers may not know the facts

It's a story as familiar as any in modern American educational life — the struggle to pay for college. The prevailing wisdom has long held that college is the key to bettering one's future — college graduates have lifetime earnings twice as high as those without a high school diploma.

Affording the investment in college, however, remains a challenge for many. One need only look at the steep rate of tuition increases over the recent past to see why. At public 4-year universities, for example, tuition increased 86.6 percent from 1997 to 2007, drastically higher than the increase in earning power over the same period.

And this is leading many to a new source of borrowing for college — private loans. A small fraction of the total student loan industry just a decade ago, private, or "alternative", loans have exploded in volume over the last few years. While federal loan volume has grown substantially over the past decade — by 107 percent — private lending has increased by 379 percent during the same period.

Traditional federal student loans are guaranteed by the government, have relatively low, fixed interest rates — 6.8 percent and 8.5 percent for Stafford and PLUS loans, respectively — and flexible repayment options. However, these loans have low borrowing limits. First year students are limited to $3,500 for their first two semesters, and dependent undergraduates can borrow no more than $23,000 during their entire college careers, although these limits will be adjusted upward in the next few years.

The low borrowing limits for federal loans may help explain the recent rapid growth of private lending, despite interest rates that can run as high as credit cart rates and may vary over the life of the loan.

The spread of private student lending worries some college financial aid professionals. Bill Spiers, director of financial aid at Tallahassee Community College, has seen private loan volume spike at his school in just the last three years — from $387,000 in 2005 to $1.3 million this year.

"That's of great concern to me," he said.

Spiers does not believe that increased private borrowing lies in increased tuition. "A few years ago, if students found out about alternative loans, they found out about them through the school. Now, they're getting three or four direct mail pieces a day. I know, because I have kids in school."

Spiers said that private loan applications take little time and many students do not want to fill out the more comprehensive Free Application for Federal Student Aid (FAFSA), which is required before qualifying for any type of federal grant or loan.

"The word that's not getting out there is that these are more expensive loans. I worry that (borrowers) don't realize private loans have fewer benefits, fewer protections, and higher fees."

Kathy Bassham, director of financial aid at Weatherford College outside of Fort Worth, has similar concerns about private loans. The increasing private loan volume has prompted the school to return to the federal loan program after being out for a decade.

"The volume of private loans that came through our office was increasing every year. Several lenders had $500,000 in loans for our students. We felt like it was time to offer them a better alternative," she said.

Bassham has now instituted a financial literacy program at Weatherford to guide students through the borrowing process.

"We're trying to use the student loan borrowing process as a teaching moment, to help them learn about money management, credit, and not borrowing too much," she said.

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For tips on how to establish high expectations for students as early as middle school and for assistance in planning for higher education academically and financially, visit www.AIE.org. TG provides this Web site has a public service to help all families and students achieve their educational goals and career dreams.

About TG
TG is a public, nonprofit corporation that administers the Federal Family Education Loan Program (FFELP). High resolution files suitable for publication are available as a free download from TG's Web site at http://www.tgslc.org/edufacts/index.cfm. For more information, please e-mail or call ray.perez@tgslc.org or (512) 219-4990.

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