Private Student Loans: The Rise And Fall (And Rise Again?)

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Five billion dollars in outstanding private student loan debt may be forgiven because of poor record keeping by financial companies, an investigation by The New York Times found this week. Loan balances are being erased and lawsuits thrown out because the loans were bundled and resold, like the subprime mortgages that precipitated the Great Recession, and the loans' current owners are struggling to prove in court that they're collecting the right amounts from the right borrowers.

Private student loans, unlike federal student loans, are not guaranteed or subsidized by the government. That means they come with higher interest rates — in the double digits, generally — and fewer repayment options.

The story raises important questions, not just about how these loans could have changed hands so many times that no one knows where they started, but also about the current state of the private student loan market.

The heyday

It turns out, students are now relying less on these risky, expensive loans and are also less likely to default on them than in years past.

The total volume of outstanding private student loans was $108 billion at the end of 2016. That's down from $150 billion five years before. It's a big number, but a small fraction of the $1.4 trillion-with-a-T student loan market.

The heyday of private student lending was in the run-up to the financial crisis, when credit standards were loose. In 2005, a change in federal law made it much harder for borrowers to shed their private student loan debt through bankruptcy. As a result, private lenders like Sallie Mae and Citibank offered hefty loans of tens of thousands of dollars to young people with no income or education (yet), knowing the IRS and courts would help them collect.

These lenders spent big money on online keyword advertising, marketing money directly to students. The annual volume of private loans skyrocketed, from $5 billion in 2001 to over $20 billion in 2008, when 14 percent of all undergraduates had one.

Around this time, a secondary market for private student loan debt also began to flourish. Lenders bundled and resold private student loans, as well as federally guaranteed student loans, which freed up more cash to make more loans. National Collegiate Student Loan Trust, the company featured in the Times story, was one of the companies that bought this old, bundled debt.

Who takes out a private student loan?

Studies by the Consumer Financial Protection Bureau and The Institute for College Access & Success have consistently found that around half of students who take out private loans have not exhausted their eligibility for cheaper, safer federal loans. In particular, students at for-profit colleges are twice as likely to hold private loans as are students at public schools.

Some for-profits lend money to their own students. A federal court found in 2015 that Corinthian Colleges, which shut down that year, was guilty of a predatory lending scheme that pushed loans on students and then tried to collect with strong-arm tactics while the students were still enrolled.

Where are we now?

The private student loan market has changed dramatically since the financial crisis of 2008.

Just before the crash, the George W. Bush administration raised borrowing limits on federal loans, particularly for graduate students. This lessened the demand for private loans.

After the crash, credit standards tightened. According to an industry report released at the end of June, 93 percent of undergraduate private student loans, and 60 percent of graduate loans, now have a creditworthy cosigner.

That same report found that delinquency rates, or the percentage of people behind on payments, are near record lows today.

But that doesn't help the private student loan borrowers of yesteryear:

Those old loans aren't going away, even as a generation of borrowers heads into the workforce and beyond into retirement. Defaults are much higher in those pre-recession private loans — and still rising. Nearly a quarter of loans given out before 2007 are in default; post-crash private loans are leveling out at a 10 percent default rate.

The secondary market for bundled student loans, known as asset-backed securities, is still going strong.

One last bit of context

Student loan debt, both federal and private, is the only category of consumer debt that continued to rise through the financial crisis and beyond. $1.4 trillion is a lot of borrowing. And within that, the annual volume of private student lending has started to creep up again: from $5.2 billion in 2010-2011 to $7.8 billion in 2014-15.

Does that mean the U.S. could still see its student loan bubble burst? Perhaps, though a slow leak is more likely, with borrowers forced to make tough choices as they begin paying back their loans.

Exhibit A: A report released this month by the Federal Reserve Bank of New York showed that rising student loan debt has depressed homeownership rates for successive generations of young people.