Getting a private> student loan is about to become easier.
A new push by private lenders and credit unions to capture some of the college lending market could open more doors for students looking to borrow, but the loans these businesses offer often come with higher price tags and less favorable conditions than those offered by the federal government.
In the last year and a half, the number of private student lenders has almost doubled, to 23, according to FinAid.org, which tracks financial aid and scholarship issues.
Some lenders are beginning to offer students private loans to make up for revenue lost by the July termination of a program that had allowed them to underwrite federal student loans, says Mark Kantrowitz, publisher of FinAid.org and FastWeb.com, another site for aid and scholarship information.
This month, community banks Mifflin County Savings Bank in Lewistown, Penn. and Manufacturers Bank and Trust in Forest City, Iowa announced that they would begin offering private student loans to borrowers in their state. Both banks are underwriting these loans through the IHELP private student loan program, which launched last November to boost private lending. The program is sponsored by the Independent Community Bankers of America.
In July, SunTrust, headquartered in Atlanta, rolled out a new private loan program with financial-services firm First Marblehead in Massachusetts. (SunTrust offers other student loans.) And in May, Wells Fargo (WFC)
Credit unions are also jumping into the private loan space. Unlike most banks that were hit hard by the recession, many credit unions have generally maintained healthy balance sheets and are looking for additional sources of revenue. By targeting students, credit unions are attempting to recruit new, lifelong customers to whom they hope to sell mortgages and other loans to later on, says a spokesman for Credit Union Student Choice, which processes credit unions loans and provides regulatory compliance.
More than 65 credit unions have entered the private student loan marketplace through CUSC since the beginning of the year, nearly 30 of which have joined since June. Another 55 credit unions have entered the marketplace through Fynanz (a company that originates, services and underwrites private student loans for credit unions), year-to-date 33 of which have entered since June.
Currently, private student loan volume is estimated at around $8 to $10 billion, says Kevin Moehn, chief executive of Moehn & Associates, a financial consulting service focused on education lending, which helped structure the IHELP program. After volume hit $24 billion during 2007-08 (in constant 2008 dollars), it declined by about 50% during 2008-09, according to the College Board.
As banks beef up their lending programs, college students should expect to encounter pitches about these private loans, Kantrowitz says.
Here are five tips to consider before signing up.
Tap into federal aid first
Before considering a private loan, students should try to get the most money they can through federal and state aid, including grants, which don't have to be paid back, and federal student loans, which tend to offer more favorable terms than private loans.
To receive federal assistance, students should submit the Free Application for Federal Student Aid on fafsa.ed.gov. Although the federal Pell grant is still available for the 2010-11 academic year for those who qualify, most state grants have already been awarded. After filing the FAFSA, students should ask their college about available federal work study jobs, assuming they qualify.
Prepare for variable interest rates
Most private student loans have variable interest rates that can change as often as each month or on a quarterly basis. (Interest rates on federal student loans are fixed.)
Currently, borrowers with high credit scores can end up with an interest rate lower than that of a federal student loan. For example, for the 2010-11 academic year, the annual percentage rates of Sallie Mae private student loans vary between 2.87% and 10.48%. By contrast, the subsidized and unsubsidized Stafford loan rates are fixed at 4.5% and 6.8%.
Interest rates on most variable-rate private student loans could climb in a few years if inflation starts picking up.
"I wouldn't be surprised if we return to historic norms within a few years," says Kantrowitz. "When interest rates are low you want a fixed-rate loan, and when interest rates are high you want a variable rate," he says.
Brace for higher overall costs
Private loans tend to cost more than federal student loans by the time the borrower has paid them down completely. That's in part because fluctuating interest rates, origination fees and other expenses can contribute to a higher total price.
Also, according to a Sallie Mae report, students who used private loans during the 2009-10 academic year reported a 15% average higher cost of attendance than students who borrowed elsewhere -- and that's because in most cases, these students who rely on private loans attend colleges with more expensive tuition.
Don't expect a reprieve on repayment
Many private student loans require borrowers to start repayment the moment they receive the loan. Federal student loans require repayment after the student graduates college.
Even after graduation, federal student loans tend to offer borrowers more favorable choices. Borrowers can enter into an income-based repayment plan, where their monthly payments are based on their income not the amount that they owe. In addition, borrowers who work in public service (as a police officer or a public school teacher, for example), can have their federal student loan balances forgiven after 10 years of repayment. These options aren't available with private loans.
Federal student loan borrowers who find themselves in financial distress can be granted deferment payments for up to three years and forbearance for up to five years. By contrast, most private loans offer a forbearance option for a shorter period, usually no more than a year. Some private lenders will charge borrowers a fee, typically around $50 per loan per quarter, Kantrowitz says.
Don't count on a watchdog soon
The financial reform legislation signed into law last month will establish a private student loan ombudsman to whom borrowers may file complaints against their lenders. The position has not been filled yet, and a deadline has not been set.
Currently, an ombudsman for federal student loans operates out of the Department of Education, but private loans are outside the office's purview.