The coming student loan crunch If you're counting on borrowing money for college next semester, get your paperwork going now. Lenders are backing away fast.
By Liz Pulliam Weston College students heading off to campus in the fall will face a radically different student loan situation than they did just a year ago.
The credit crunch that rattled mortgage lenders has spread to the education lending market, with dramatic results. If the situation doesn't ease in coming months, student lending experts say, borrowers can expect:
Higher loan costs.
Fewer lenders, which could mean tens of thousands of college students scrambling at the last minute to find money.
Tougher standards that could prevent some students from borrowing at all.
"It's a very different situation from last year," when lenders were falling over each other to compete for students' business, said Kevin Walker, the president and CEO of SimpleTuition.com, a student loan site. "And it's probably not clear to the consumer that this problem is looming."
Like mortgage lenders, student loan companies were criticized in recent years for loose standards that saddled many students with massive debts. Although student lenders didn't rush into the subprime market that eventually backfired with mortgages, they lavished loans on borrowers with little concern about their ability to repay. (Read "How did student loans get so sleazy?" for details.)
A perfect storm for student loans The easy-money blitz for students has been threatened on a variety of fronts:
Student loan defaults are up. The biggest student lender, Sallie Mae, reported a massive $1.6 billion loss last quarter, thanks in part to spiking default rates, and plans to set aside an additional $700 million to cover bad loans this year. Although the U.S. government guarantees lenders will be reimbursed for federal student loans, the bulk of Sallie Mae's losses were from private student loans, which aren't guaranteed.
A key source of funds has dried up. As investors become increasingly spooked about the credit crunch and the rising risks that loans will go bad, they're avoiding buying bundles of loans, known as asset-backed securities, that are a major source of funding for some student lenders. This aversion applies even to federal student loans despite the government guarantee. Several recent auctions of federal student loan debt have failed, meaning that investors who hold the loans couldn't find any buyers. Without this critical source of funds, some lenders can't make loans.
Meanwhile, one state lending agency, the Michigan Higher Education Student Loan Authority, suspended its loan program, and Michigan's deputy treasurer predicted to The Wall Street Journal that other state agencies would soon face the same crunch.
"What's happening is investors are shy of everything" in credit markets, said Mark Kantrowitz, the founder of FinAid.org, an online guide to student financial aid. "Investors are overreacting."
Deborah Fox, who advises families on college funding strategies, predicts rates may climb as much as a percentage point as lenders struggle with the securities markets.
Video on MSN Money: Multimedia on MSN Oops! Forgot to save for college
Need help paying your kids' tuition? It's time for them to start taking some financial responsibility for their education.
"Variable rates that should be coming down in a low-interest-rate environment will be moving in the opposite direction," said Fox, of Fox College Funding, "which will put further pressure on the American consumer who is attempting to keep their head above water in what appears to be a recessionary environment."
Other sources of cash are more expensive. Not all lenders get their money from investment markets. Sallie Mae, for example, will tap a recently arranged $31 billion line of credit extended by Bank of America and JPMorgan Chase. But even lenders that don't rely on the asset-backed-securities market are paying more for the money because of the credit crunch, Kantrowitz said. Lenders will pass those costs along, he said, in higher fees and fewer discounts.
Continued: Lenders are cutting back
Some lenders have already cut back on federal student loans, and more may follow. Congress trimmed lenders' profits last year by reducing their federal subsidies by about $20 billion. That, combined with higher costs of funds, has persuaded some lenders to stop making certain federal loans or to concentrate on the private loan market. (Unlike federal loans, private loan rates aren't fixed and can range up to 19%. These loans grew in a single decade from less than 5% of the student loan market to more than 20%.)
"Tens of thousands of students are expecting to go back to the lender they used last year, and those lenders won't be available," SimpleTuition's Walker said. "They will be confused, and there will be a scramble (to find lenders) right as the bills are due."
Many lenders are becoming pickier about who gets money. Some lenders are signaling they may loan less, or nothing, to institutions that don't have a high graduation rate, such as for-profit and vocational schools. The notion here is pretty simple: Education works to boost your income only if you actually get a degree, and folks who fall short of that mark may not make enough to pay back the loans.
"They're saying, 'We want to focus on making loans to people who are going to graduate, instead of people who are just going to school,'" Walker said. That means schools with relatively high dropout rates "are going to feel pinched."
That might save some people from racking up tens of thousands of dollars of debt they can't repay and can't shed (unlike many other unsecured debts, student loans typically can't be erased in bankruptcy court). But it may cost others "the opportunity to do something they've always wanted to do," Walker said.
Another significant change has to do with credit scores. Federal student loan programs typically don't use credit information, but most private lenders in the past have required a minimum FICO credit score of 675, Walker said. (The traditional start of the subprime market, by contrast, is 620 on the 300-to-850 FICO scale.)
"Now they're tightening up lending criteria so that instead of 675, 695 will be the minimum," Walker said.
In addition, lenders are likely to add fees that reflect borrowers' creditworthiness. Though people with the best credit scores might pay no fees, Kantrowitz said, those with shakier credit could pay fees of 3% to 10% for a loan.
3 ways to cope Clearly, it's a new world for student borrowers. So what's a college-bound student to do? Here's your game plan:
Don't procrastinate. As soon as you get your financial-aid letter in the mail, start investigating possible lenders. Remember to exhaust federal student loans before turning to the private market, since federal student loans have fixed rates and are more flexible than private loans.
Video on MSN Money: Multimedia on MSN Oops! Forgot to save for college
Need help paying your kids' tuition? It's time for them to start taking some financial responsibility for their education.
Bug your financial-aid office for advice. Some aid officials got black eyes for steering students to certain lenders in exchange for kickbacks. But financial-aid offices are still the best place to go, Walker said, to get the scoop about which lenders are available and which aren't.
Get a co-signer. If you have to use private loans -- and many students do because the most you can borrow in federal loans for an undergraduate education is $23,000 ($46,000 if you're an independent student or a dependent student whose parents have been denied PLUS loans) -- burnish those credit scores or get a co-signer who already has. A co-signer with great credit can help you avoid fees and win a much better rate on your loans, which can save you thousands of dollars.
Liz Pulliam Weston's new book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.
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