A Shaky Season for Student Loans

Subprime woes and recent legislation have lenders tightening standards for applicants, and the credit crunch is eating away at other sources for tuition money

by Alison Damast

Shortly after New Year's Day, Pat Watkins, financial aid director at Eckerd College in St. Petersburg, Fla., placed a worried call to National Education, a student loan company she has been working with for nearly two decades. She had heard rumors that the company was no longer funding federal Stafford and PLUS (Parent Loans for Undergraduate Students) education loans, but had received no official word from the company.

She found out that the phone of National Education's local rep had been disconnected. Later she learned that Chicago-based National Education was not planning to accept applications for new loans for the spring semester after Jan. 15, though they planned to fund disbursements for students who received loans for the fall.

Federal Loans Lose Funders

That was the first surprise. In mid-January, Watkins received a letter from Phoenix loan company NextStudent saying they, too, would not be funding new Stafford or PLUS loans for the spring semester, only funding loans where there has been a fall disbursement.

At least one other student loan company, San Diego-based Goal Financial, has also pulled back their federal loan lending, according to college loan officials. Federal student loans are low-interest loans guaranteed by the federal government. Congress outsources many of these loans to private companies and has recently passed legislation that has eliminated many of the subsidies they gave these lenders to encourage them to participate and administer the federal loans.

"I haven't seen it this bad before," said Watkins, who has worked in the financial aid industry for 34 years. "It is going to put a lot of students in a bind." She said she will help students find a new loan provider, but for students with existing loans this will likely incur more costs and a second loan to be repaid.

Student financial aid season—which started on Jan. 1—is getting off to a shaky start. The industry is experiencing jitters as the fallout from the subprime credit crisis trickles down to lenders who make private loans, as well as companies that also issue federal loans. For the moment, the credit mess has had a limited effect on student borrowers, but experts said they expect students to be affected in the next few months.

Tougher Standards

For instance, students with poor or only decent credit ratings—those with FICO credits scores under 650—may encounter difficulty obtaining a private loan with reasonable interest rates or, for that matter, obtaining one at all. Loan companies may refuse, in some cases, to make loans to students at schools that have high default rates, financial aid directors said. And families that have relied on home equity borrowing to pay college costs may turn to private lenders as the home equity market tightens up (BusinessWeek, 1/16/08).

Students also may need to change their loan application tactics. In the past, students who were authorized account holders on their parents' credit cards could get loans with interest rates based on their parents' credit rating. They now will be required in most cases to apply for such loans with their parents as co-signers. Those applying for federal loans may also find their options more limited, as many major loan companies that work with the federal government temporarily pull out of the federal student loan program.