Is history about to repeat itself? There are some striking similarities between the private student loan market and subprime mortgage industry. A new report from the Consumer Financial Protection Bureau (CFPB), provides more evidence for the comparison.
“Student loan borrower stories of detours and dead-ends with their servicers bear an uncanny resemblance to problematic practices uncovered in the mortgage servicing business,” said Rohit Chopra, student loan ombudsman for the CFPB who authored the report, in a prepared statement. “Consumers deserve clarity, not chaos and confusion.”
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The report analyzed roughly 2,900 complaints, comments and other submissions and input from borrowers since March of this year. With student loan debt crossing the $1 trillion milestone earlier this year, and private student loans accounting for more than $150 billion of that, another crisis could be on the horizon. There are at least $8 billion of private student loans in default, representing more than 850,000 individual loans, according to the report.
“It's hard to predict when the student loan meltdown could occur, but if the bubble explodes, the consequences will be devastating for the economy,” says Howard Dvorkin, author of Credit Hell. With 40 percent of households headed by an individual under 35 having student loan debt, the economy is already feeling some of the effects. Census data reveals that 6 million young adults ages 25-34 lived with their parents in 2011, and the National Association of Realtors estimates that young adults made up only 27 percent of all home buyers in 2011, the lowest share in the past decade. With onerous student loan debt, many students have failed to launch because they can't afford the rites of passage to independence.
According to Glenn Reynolds, author of The Higher Education Bubble, “Bubbles form when too many people expect values to go up forever. [They] burst when there are no longer enough excessively optimistic and ignorant folks to fuel them,” he writes. “And there are signs that this is beginning to happen where education is concerned.”
Here's a look at the similarities between the subprime mortgage industry and the private student loan market:
1. Good Intentions Gone Bad. Society puts a high value on the two objectives – education and home ownership. “A college education is a path to life success just like home ownership is a path to financial stability. In reality, some people aren't suited for it,” says Ken Lin, founder and CEO of educational website, CreditKarma.com.
2. Misleading Interest Rates. Lin says both industries have artificially low interest rates. “With mortgages it was to stimulate home ownership, in student loans it was to promote education,” says Lin. However, “What students don't know is that the interest rates on these loans will increase dramatically over the years, so a $30,000 loan can become $50,000 due to changing interest rates,” says Dvorkin. Interest rates on private student loans can be anywhere from 5 percent to 18 percent.
3. Lack of Scrutiny. Both industries didn't have a great litmus test for qualification, says Lin. “In mortgages we were supposed to make sure people have good credit and can pay the loan back. We know [how] that ended. In student loans, the students are supposed to pass aptitude tests, but for-profit universities are basically letting anyone into these loan programs. When people aren't qualified for the product, we have lots of issues,” says Lin.
Then too, “Both industries use the same abusive lending practices, including lowering the credit score requirements to obtain a loan and overall qualification requirements,” adds Dvorkin. The subprime mortgage industry behaved in a similar way before the housing market collapse. “When the economy was growing, lenders relaxed the requirements to obtain a mortgage, inducing many individuals to get loans they couldn't afford. Once the economic crisis began, borrowers couldn't afford their mortgage payments anymore,” says Dvorkin.
The subprime mortgage industry was marred by confusion, and the same could be said for some private student loans. Whether looking for accurate information, trying to find payment options, or simply trying to get payments processed properly, many borrowers complained about getting the runaround, according to the report. Some borrowers even reported that after they graduated they had a hard time figuring out how much they owed and when they needed to start repaying.
4. Government Guarantees. “In both industries, the government is the backstop for the loans. In the subprime space it was Freddie and Fannie. In the student loan space, it is the Department of Education,” says Lin. Before the Student Aid and Fiscal Responsibility Act was signed in 2010, the government would give subsidies to banks and loan servicers to guarantee that student loans would be profitable and risk-free. At one point, $8.80 of every $10 spent in student lending activity was from the federal government, according to the House Education and Labor Committee.
5. High-Pressure Sales Tactics. “There are the same 'boiler room' pressure tactics applied at some schools, especially at for-profits. Many will not publish their tuition charges on their websites so that applicants are forced to speak with sales pros to find out all relevant facts,” says Terry Connelly, co-author of Riptide: The New Normal in Higher Education. Furthermore, the complaints received by the CFPB resemble many of the same issues experienced by mortgage borrowers – ”misplaced” payments, delayed error resolution, inability to contact the appropriate person in times of hardship, inability to take advantage of low interest rates due to a lack of refinance options, and inability to secure modified payments plans during the difficult labor market.
While the similarities are striking, there are a few key differences. With a mortgage, one can walk away and be absolved of that debt, but there's no bailout for student loans. “Student loan debt is almost never dischargeable in bankruptcy,” says lawyer David Leibowitz, co-chair of the consumer bankruptcy committee at the American Bankruptcy Institute. “This debt will last from graduation literally to the grave. There is no social or financial safety net.”
Unlike mortgages, student loans have almost no credit requirements. “Even in the subprime debacle, not everyone could get qualified,” says Lin. In addition, mortgages are secured with the property, but student loans have little intrinsic value, particularly when the degree is not completed. This creates more risk since you can't recoup most of the value in a default, says Lin.
However, there is one plus: The private student loan market is smaller than that of subprime mortgages. In 2006, there was $600 billion in subprime mortgage lending. In 2008, students borrowed about $20 billion in private loans. And due to tighter credit standards and regulations, that number has decreased significantly today.
To prevent another catastrophe from happening, the CFPB is urging decision makers to increase the availability of loan modification and refinance options for student loan borrowers. They also recommend increasing the adoption of income-based repayment for federal student loans. CFPB points out that many students that have private loans also have federal loans. One way they might be able to better meet their private loan obligations is to reduce their payment on their federal loan through income-based repayment.