Credit market constriction is limiting the financial aid available to college students. Here are some tips for shopping for a private loan
The college acceptance letters are coming in, and for many families the search for student loans is just beginning. For this year's crop of students, however, shopping for a loan, especially a private student loan, can be more difficult than usual because of turmoil in the credit markets (BusinessWeek.com, 1/17/08).
In the past few months, dozens of lenders have announced they are suspending some of their student loan programs or, in some instances, eliminating them entirely. The financial aid Web site FinAid.org, reports that 37 education lenders have exited or suspended their participation in all or part of the federally guaranteed Federal Family Education Loan Program. The outlook is grim for private lenders as well. Eleven lenders have suspended their private student loan programs, and seven nonprofit state loan agencies are also halting some programs.
"We're not trying to put fear into family and students' minds…but I think people will have to start earlier and work harder to ensure they can get the level of student loan they need," says Brett Lief, president of the National Council of Higher Education Loan Programs, a group that represents guarantee agencies and nonprofit lenders.
Caught By Surprise
The situation—a combination of the collapse of a previously obscure corner of the financial market known as auction rate securities and fallout from the subprime mortgage crisis—has gotten so dire the future of the student loan industry appears, for the first time, precarious. Last week, the Education Dept. issued guidelines for "lender-of-last-resort" programs, a stopgap measure that will ensure certain students can obtain loans in the case of the government announcing a loan emergency.
Bob Giannino-Racine, executive director of ACCESS, a Boston nonprofit that helps low-income student and families find loans, says he and others in the industry have been caught off guard by the rapid unraveling of the market. "It probably shouldn't have, but that issue caught a lot of us by surprise over the last few weeks," Giannino-Racine says. "If this is as big a problem as it seems, it could hit us like a ton of bricks."
Financial aid counselors are concerned as well. In a Mar. 25 letter to the Senate and House education committees, Philip Day Jr., the president of the National Association of Student Financial Aid Administrators, urged legislators to take action to ensure students have guaranteed access to loans this fall. His organization has "considerable apprehension about the future of student lending," he wrote. In the letter, he pointed out that more banks that make government-guaranteed student loans are leaving the market every day, including, most recently, HSBC (HBC), M&T Bank (MTB), and TCF Financial (TCB). On Mar. 27, Salt Lake City-based Zions Bank (ZION) announced it plans to withdraw from the federal student lending program as of Mar. 31.
Tips for Loan Shopping
In this shaky lending landscape, a student seeking a loan might be tempted to take the first offer that comes along. But taking the time to research and compare offers is well worth it. This practice is even more important in the private loan market, where interest rates and repayment options vary widely.
Keep the following tips about private student loans in mind as you explore the student loan market this season.
Exhaust Federal loans first. "Private loans should absolutely be a last resort for a student," says Mark Warner, University of Iowa's student financial aid director. Federal loans have a set interest rate that is fixed by the government for the life of the loan. Private loans may not. First explore subsidized Stafford loans, which are based on need, do not accrue interest on the loan while in school, and have a fixed interest rate, currently 6.8%. An unsubsidized Stafford loan, which isn't need-based and does accrue interest while in school, is another option. If families need additional aid, they should consider applying for a Federal Parent Plus Loan, a low-interest student loan for parents of undergraduate, dependent students.
Whatever you do, don't avoid applying for federal loans because you don't want to spend the time filing the Free Application for Federal Student Aid, the first step to securing a federal loan, says Kalman Chany, author of Paying for College Without Going Broke and president of Campus Consultants, a college advising company. Doing so can be costly in the long run.
When to turn to private loans. Federal loans can be helpful to families only up to a point. Private loans have become a necessary last resort for student and families, depending on their circumstances. Some families, especially in the current economic downturn, are being denied Federal Plus Loans because of an adverse credit history, which can include foreclosures in the last five years, bankruptcy, or being 90 days or more late on repayment of debt. If Stafford loans don't meet their needs, they need to apply for private loans to make up the balance of financial aid. Other students who must turn to private loans are international students, who are not permitted to apply for the federal loan programs. They are also a valuable resource for independent students without parents or guardians.
Start loan shopping close to home. Start your search for a private loan at the college student financial-aid office. Since New York State Attorney General Andrew Cuomo revealed last year that many financial-aid officers at colleges and universities across the country were accepting gifts, vacation, and financial rewards from private lenders, schools have tightened criteria on which lenders they may refer students to during their search. Still, FinAid.org's publisher Mark Kantrowitz says the "first place any student should go to look at is their school's list." He adds: "The schools still have the preferred lenders list, but they are being more careful in how they make recommendations and how they list them, but they are still a good source of info."
Be aware of different categories of private loans. There are two types of private loans available to students: school-certified and non-school-certified. The interest rates and fees tend to be lower for school-certified loans because the school will verify enrollment for the lender and the amount of money the borrower can get is limited to their expected family contribution.
Students can also turn to financial-aid reference sites like FinAid.org, a virtual telephone book of student loan providers. The site lists the best and worst rates for private student lenders.
Don't discount nonprofit lenders. One of the best sources of private student aid are the state-based nonprofit agencies that help students secure low-cost private loans. These providers often offer attractive interest rates, comparable to, or, in some instances, better than federal loans and most private ones. However, many of these agencies, including those in New Hampshire and Massachusetts, have been hit hard by the credit crunch and some have withdrawn entirely from the loan market. For example, Iowa Student Loan Liquidity, Iowa's nonprofit lending agency, will stop offering private student loans in April.
Students should investigate the nonprofit provider in their state to learn whether they are still making student loans. If a student is attending school out of state, they can apply to the loan authority in their home state, as well as the one in the state where they will be attending college, says loan consultant Chany.
Don't apply for too many loans. A big mistake is applying for too many loans in a short time. One thing most loan shoppers don't realize is that every time they apply for a loan, the applicant's credit score is reduced by five points, says FinAid's Kantrowitz. Most private lenders have five or six tiers of different interest rates and fees they offer borrowers, which they dole out based on credit score. Applying to eight or nine lenders could mean you will end up with a lower credit score, and, consequently, a less favorable interest rate. Kantrowitz recommends students apply for, at most, three or four loans. Ideally, these lenders should include a bank, a nonbank specialty lender, and one or two state loan agencies, he says.
Beware of loan comparison sites. Several Web sites promise to help students obtain "bids" for student loans, similar to mortgage shopping sites. Kantrowitz warns that none, so far, have lived up to their billing.
Consider a co-signer. If at all possible, use a co-signer when signing up for a private loan. This is especially important with private student loans, because lenders look at the higher of two credit scores to determine eligibility, interest rate, and fees paid. Some students may not want to place this burden on their parents, but that can be a mistake in the long run, says Kantrowitz. "I've talked to students who have said, 'My parents have done enough. I don't want them to take on any more debt for me.' But the reality is that it will be costing [the students] more," Kantrowitz says. "You may have your principles, but in this case your principles are going to cost you."
Ask plenty of questions. Once students have narrowed down their loan options, they should ask questions to determine whether a particular loan is the right fit. The first thing to do is nail down the interest rate, says Robert Shireman, executive director of the Project on Student Debt, a group that raises awareness about financial aid. "It's disturbing how hard it is to get an ironclad interest rate from a lender," Shireman says. "You really have to go through the whole application process and give them access to your credit record."
Other questions: Is the interest rate of the loan fixed or variable? If variable, is there a cap? How is the interest rate calculated (is it based on the prime rate or the LIBOR (London Inter-Bank Offered Rate)? When does repayment begin? Can you defer your payment until you are done with school? Will you be able to afford your monthly payment?
With these answers in hand, students and parents can make informed decisions on loans. Consultant Chany cautions that this isn't a decision to be made quickly: "It's not just, 'Well, I'll get this over with,' because then you might be locked into the loan product for the life of the loan."