By Mitchell D. Weiss
The Consumer Financial Protection Bureau (CFPB) recently issued its report on private student loans (PSLs).
It describes how PSL growth exploded during the run-up to the 2008 collapse -- and even since that time -- because of the same credit underwriting, regulatory oversight and consumer disclosure deficiencies we've seen with other types of lending (mortgages would be a pretty good example). The report also sets forth a series of sensible recommendations for the future, which are further reinforced by the secretary of education.
The CFPB document is, in many ways, damning -- of the financial institutions that deliberately bypassed college financial aid offices in order to market costly and complicated loan products directly to a naïve and needy customer base; of a Congress that permitted consumer protection laws (most notably those pertaining to bankruptcy) to be weakened to the point that a generation of young, imprudent borrowers is threatened; and of the schools that took advantage of the easy money their poorly informed student-customers had access to.
But for all the light this report sheds on a problem that's become a crisis, I wish there had been more, particularly in the following areas:
Interest Rates
The CFPB describes how loan rates are set and how variable payment plans can significantly affect affordability. It also discusses how previously weak credit underwriting now carries much stricter standards (for example, cosigners are now required for more than 90 percent of the loans) and how profit margins have widened overall.
However, while these stricter underwriting and pricing standards may be linked to borrower (and cosigner) creditworthiness, the CFPB fails to call into question the connection between this risk-based pricing approach, as it's known, and the principal offset against that risk -- that is, the virtual inability for these debts to be discharged in bankruptcy.
High risk equals high rates; low risk equals low rates. You can't just pick the best part from each of these equations -- high rates and low risk -- and yet, that's exactly what PSL lenders continue to do.
Loan Workouts
The report also highlights the failure of lenders and the companies that service the loan contracts to provide "rehabilitation" assistance that's comparable to the government's Income-Based Repaymentand Loan Forgiveness programs. And while it correctly attributes part of the problem to the securitization process, where the ownership of these loans is harder to pinpoint, the report doesn't mention how it typically provides ample latitude for the remediation of problem accounts.
Therefore, I have to conclude that the investors and/or their agents are simply choosing not to intervene, and wonder whether this decision is tied to the aforementioned bankruptcy limitation.
Modifying the bankruptcy laws -- as the CFPB recommends for Congress to consider -- will force the private lenders, investors and their loan-servicing agents to see the error of their ways.
Loan Portfolio Management
Speaking of loan servicing, the report doesn't address the relationship between the entities that manage routine repayments and those that deal with problem accounts, whether they fall under the private or government-sponsored programs.
In particular, I'm focused on relationships such as the one between Sallie Mae and its subsidiary Pioneer Credit Recovery, which happens to be one of the government's nearly two dozen authorized private collection agencies (PCAs) that are tasked with collecting past due and defaulted student loan payments.
There's nothing remarkable or inappropriate about the concept of a loan originator owning a debt collections company. In fact, there's a good case to be made for the efficiencies to be had in a distressed account's seamless transfer from one side of a lending operation to another.
But because money's involved -- a lot of money, actually, as nearly $1 billion in fees were paid by the federal government to its PCAs in 2011, according to the National Consumer Law Center's May 2012 report -- I think it's important to zero in on how these firms guard against gaming the system by "managing" their delinquencies.
I'm talking about a process that allows loans to slip into past-due status for the benefit of the additional revenues that come from the late fees and other collections-related charges that are typically assessed.
Let me put it this way: loan servicers earn money for collecting loan payments in the normal course. They earn even more money for collecting problem loan accounts, and all of it is in addition to whatever they may have earned to originate the loans in the first place. As such, I worry about the temptation to double or triple dip.
Loan Amount Limits
One of the recommendations the CFPB makes is for PSL lenders to obtain certifications from the schools that its students' prospective borrowing amounts don't exceed their actual education-related needs, which the CFPB views as a way of curtailing excessive borrowing. I would prefer to see this done a little differently.
Undergraduate Stafford loan limits should be increased on par with the average starting salary for college graduates as reported by the National Association of Colleges and Employers(NACE), and loan durations should be lengthened so that their loan repayments are kept within a very manageable 10 percent of that projected gross salary.
For example, according to the NACE's 2012 report, average 2011 college graduate earnings were just under $42,000. Ten percent of that is $4,200, and one-twelfth of that amount is $350. Therefore, at the 6.8 percent unsubsidized Stafford student loan rate, borrowers would need a little less than 17 years to pay off their loans, versus the standard 10-year repayment term (which works out to 14 percent of the gross salary).
One Last Thing
Given all the attention that this good report has garnered since its publication, I'm most disappointed that the CFPB didn't leverage the publicity by addressing the most pressing issue facing student borrowers: what to do about the money they currently owe and are struggling or unable to repay.
The student loan default rate is hovering around 10 percent and payment delinquencies are running 27 percent, according to the Federal Reserve Bank of New York's March 2012 report. Clearly, this problem isn't going away. Not without a significant intervention.
The nation's education loans -- private and government alike -- need to be consolidated and restructured within the context of an expanded Income-Based Repayment program that is more flexible and inclusive. Only then, can we hope to save a generation of borrowers who will otherwise continue to earn, produce and consume less than their parents.
This article originally appeared on Credit.com. Mitchell D. Weiss is an adjunct professor of finance at the University of Hartford and author of Life Happens: A Practical Guide to Personal Finance from College to Career and College Happens: A Practical Handbook for Parents and Students.
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The cost of college today is obscene. If we can't bring that down by half, we'll end up with a more poorly educated general population that won't be able to sustain our economy in the future. To some extent, this is already the case.
MSU President Randy Dunn says he couldn’t be happier for holding the distinction that 77% of Racers receive merit-based scholarships and grants – rather than loans – to cover some of their tuition. More: http://collegebubble.net/?p=890
But they are sold as if they buy a degree and buy a job making a pre-determined amount of money. If it worked that way, I would be less opposed to someone digging themselves into debt.
And the whole thing has the unintended consequence of teaching young people that debt is good. So the breathing room the student loans create becomes daylight to tack on more debt for nicer cars, credit cards, and bigger houses. Then the debt burden becomes enormous and makes it harder to pay the student loans off early.
I recognize student loans can work out well in many cases. But my view is half or more are harmed financially as a result of student debt. Debt/leverage works great when it works. But it can take your head off when it doesn't.
Thanks again for your reply.