By Michael P. Tremoglie

NEW YORK (

MainStreet

)--It is an arrangement that organized crime might envy - the lending of money with less concern about the ability to repay than is normally required for other loans, yet an almost absolute certainty that the debt will be repaid.

Sounds too good to be true?

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Maybe, but it happens thousands of times a day, every day, every year on college campuses throughout the United States of America - the land of the free and the home of the in-hock-forever college graduate. These 18- and 19-year-olds borrow thousands of dollars, indeed tens of thousands of dollars, and occasionally hundreds of thousands of dollars, from financial institutions in unsecured debt to pay for their college tuition. The interest rates are usually variable.

Most of all, the indebtedness is near impossible to discharge in a bankruptcy.

The problem is so grave that the Consumer Financial Protection Board (CFPB) noted it in a report they issued in July 2012 about private student loans - those not guaranteed by the federal government. According to the CFPB, "...the Sample Lender Portfolio and loan-level data illustrate a credit boom that led to lax underwriting standards on a number of dimensions and a bust that has led to a significant tightening of those underwriting standards."

The CFPB is not alone in their criticism. Barmak Nassirian, an independent consultant, who was formerly an associate executive director for external relations for the American Association of Collegiate Registrars and Admissions Officers (AACRAO), a nonprofit association of about 9,000 campus administrative professionals, in Washington D.C.

"The entire interest rate risk is shifted entirely to the borrower. They offer variable rates, with very high or no cap at all," he explained. "Who needs underwriting when you have an indenture contract? These loans are underwritten, but they are almost guaranteed to be collected, so it is easy to sell the notes."

CFPB further emphasized the lax underwriting standards in their report. They note that investors wanted asset-backed securities.

The report states, "Fueled by investor appetite for asset-backed securities, the financial institution private student loan market grew from less than $5 billion in 2001 to over $20 billion in 2008, before contracting to less than $6 billion in 2011. From 2005 - 2007, lenders increasingly marketed and disbursed loans directly to students, reducing the involvement of schools in the process; indeed during this period, the percentage of loans to undergraduates made without school involvement or certification of need grew from 18% to over 31%."

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The CFPB pointed out the results of this extravagant lending. It affirmed, "As a result, many students borrowed more than they needed to finance their education. Additionally, during this period, lenders were more likely to originate loans to borrowers with lower credit scores than they had previously been. These trends made private student loans riskier for consumers... Accordingly, to the extent lenders underwrite on the basis of the student's application rather than the creditworthiness of a co-borrower, lenders must choose some basis to distinguish borrowers who are more or less likely to repay out of a group of borrowers who have little to no credit history and whose future earnings are uncertain."

This is tantamount to a 19-year-old walking into a Lexus dealership to buy a car. The dealer says sure just fill out this application and directs the buyer to a finance company that will lend money. He does not have an employment record, except for a couple of part-time jobs after school. He has no credit rating. The only money he ever borrowed was from his parents.

The finance company will give the young man thousands of dollars. Maybe the lender will ask for a co-signer. If the borrower cannot pay back the debt too bad. It cannot be discharged in a bankruptcy.

The CFPB did say however that corrective action by lenders was taken. The report noted, "Private student lenders have addressed these issues in recent years by requiring borrowers to either be independently creditworthy or have a creditworthy cosigner."

Whatever may be the case now some - including the CFPB - feel that the loan underwriting was lax in the past.

"The point is that these loans were handed out like candy," emphasized Claire Law, a certified educational consultant. "The Promissory Note is good for ten years - so more loans can be added to the first one without need for more signatures."

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But lenders deny that the underwriting is lax. Discover Student Loans and Sallie Mae, the nation's largest student lending institution, both claim that they vigorously underwrite the loans.

"Like other Discover consumer loans, Discover's student loans are fully underwritten, including a credit review, to determine whether the credit strength of the borrower will support repayment of the loan," said Abbe Kalina, Discover's senior manager of public relations stated. "Determining the ability to repay the loan protects borrowers against unnecessary borrowing and facilitates successful repayment performance."

She elaborated by saying, "For potential borrowers to receive for a Discover Student Loan, they must undergo a multiple step process that begins with determining their eligibility." For students to be eligible to be considered for a Discover Student Loan, she noted, they must:

Be enrolled at an eligible school (or in the case of residency and bar exam applicants, they must be enrolled or recently graduated with a qualifying degree at an eligible school)

Be making satisfactory academic progress as defined by the school

Be a US citizen, permanent resident or international student with a Social Security number

Must be 16 years or older at the time when they apply

Must pass a credit check

"While our underwriting is proprietary, I can tell you that we use a variety of factors," said Sallie Mae spokesperson Patricia Nash Christel. "If a primary borrower has little or no credit history, we may require the applicant to apply with a creditworthy cosigner. The loans we originated in the first quarter had an average FICO score of 744."

But even Sallie Mae said that such stringent underwriting standards were not always the case. Sallie Mae CEO and President Jack Remondi said as much in testimony, July 24, 2012, before the Senate Committee on Banking, Housing and Urban Affairs Subcommittee on Financial Institutions and Consumer Protection.

"In academic year 2007-08, students and families borrowed $23.2 billion in ―non-federal,‖ or private education loans, representing about 6% of all spending on higher education," Remondi testified. "With increases in federal loan limits, more robust underwriting standards and a very difficult economic environment, three years later, in academic year 2010-11, students and families borrowed less than $8 billion in non-federal education loans, representing about 1% of total spending on higher education."

He stressed that their portfolio and underwriting is sound. He mentioned that the vast majority of our customers are successfully making on-time payments adding that 90% of the loans are in repayment and current. He also said that delinquencies have steadily declined and charge-offs have dropped.

But the CFPB report notes that many borrowers are not repaying their loans. It states: "In 2009, the unemployment rate for private student loan borrowers who started school in the 2003-2004 academic year was 16%...Cumulative defaults on private student loans exceed $8 billion, and represent over 850,000 distinct loans."

But Remondi placed the onus on the borrowers. He cautioned them to be more wary. He proclaimed in his testimony that, "Students and their families need to assess the total cost of education, not just the bill for the current semester, and be sure that what they borrow is what they can afford based on current and projected financial resources."

One who concurs with Remondi, in part, is Bill Bennett, who from 1985 to 1988 was the U.S. Secretary of Education. He is the author of the new book,

Is College Worth It?: A Former United States Secretary of Education and a Liberal Arts Graduate Expose the Broken Promise of Higher Education

(Thomas Nelson, 2013). He said student indebtedness is at a crisis stage. But in his opinion, there is plenty of blame to go around.

"This is been happening for a long time," Bennett said. "One of the conclusions we come to in my book are that more people have to have skin in the game."

He faults the lending institutions, because often they believe they will get bailed out. He feels that student loan indebtedness affects not only the economy and but the society at large. Young people will delay purchases and delay starting families while they are paying off their debt.

"The entire thing is a mess--it is probably going to burst," Bennett said. "Another thing is, as I say in...my book, is that the ready availability of money is another factor driving up the cost of college education."

But he also says the lenders are not totally responsible for the debacle. Consumers have to share the blame.

"I don't think we will ultimately get all the answers on how banks calculate their lending methodology, but this problem is a two-way street," Bennett said. "I think banks are generally applying best practices in deciding who to loan money to, but it is still troubling that students can ruin themselves financially by borrowing lots of money for tuition or living expenses."

Bennett said that student lending and student borrowing practices need to be evaluated more than they are. He is concerned about the ultimate result of the profligate lending.

"Students should carefully think through how much money they need to borrow, and banks, for their part, should re-examine how much they should allow a student, perhaps one with little financial literacy, to borrow," Bennett said. "This is an underexplored ethical question for the principal actors in the student lending game: banks and the federal government -- are we unwittingly helping to create a class of overly indebted citizens?"

Overly indebted or not, one aspect of student loans is they must be paid.

--Written by Michael P. Tremoglie