Updated on March 26, 2009>.
Getting accepted into> a top-choice university or college used to be the biggest challenge students faced with the application process. But now, many face an even bigger hurdle: landing a private student loan.
Blame it on the credit crunch, which in 2008 prompted several major private student loan lenders, including Bank of America (BAC)
Those who do manage to land a loan must brace themselves for high interest rates, says Mark Kantrowitz, publisher of FinAid.org. Interest rates on these loans now average between 12% and 14%, up from 10% to 11% in 2007, he says. Some rates even hit close to 19%, according to the National Consumer Law Center.
Making matters worse, rising tuition and other costs are forcing more students to seek private financing. Private loans already comprise about 23% of the education loan volume in the U.S., and their yearly growth is outpacing that of federal loans, according to the NCLC's March 2008 survey.
"Students are faced with problems on several fronts," says Deanne Loonin, director of the Student Loan Borrower Assistance Project, part of the NCLC. "If the economy doesn't improve, it will become harder to get approved for these loans. And it will become even harder to repay them."
Here's what students (and their co-signers) need to know before they start shopping for a private loan:
The pool of private lenders is shrinking fast.
Since September 2007, 45 lenders suspended their private student loan programs, according to Kantrowitz. Of those, more than five exited the marketplace since the beginning of the year, Main Education Services, Access Group and Campus Door, a unit of Lehman Brothers, he says.
While less than two dozen lenders still underwrite private loans, many of them have such strict requirements that few borrowers are eligible, says John Hupalo, a former chief financial officer for First Marblehead Corporation (FMD),
Higher Credit Score Requirements
As the credit crunch continues to tighten its grip, skittish lenders are being extremely selective about who they lend to.
Last year, a borrower could get approved for a private student loan with a credit score of as low as 620, says Kantrowitz. Now, some lenders require at least a 650 to 680, while others won't even look at an applicant with a credit score below 730. For a loan with the lowest interest rate possible (prime rate minus 0.5%, or the London Interbank Offered Rate (LIBOR) plus 2.25%) and low origination fees, the applicant needs at least a credit score of 810, which only 5% to 6% of borrowers have, he says.
High credit scores are rare among college students who tend to have a short or nonexistent credit history. That's where the co-signer comes in.
Bring a parent or older relative to the table who'll pledge equal responsibility for repaying the loan. Lenders always prefer doling out loans to students who have a co-signer, but now most of them are requiring it, says Hupalo. "Lenders are trying to keep their risk as low as possible. And student loans -- with higher co-signer rates -- have fewer delinquencies and defaults," he says.
Rising Interest Rates
Interest rates on private student loans are rarely set in stone. In fact, students can expect the rate to rise several times through the repayment period. Before signing up for a loan, make sure to understand the terms and how the interest rate can fluctuate.
Most private student loans carry variable interest rates that are pegged either to the prime rate, which is the rate at which financial institutions lend to customers, or to the LIBOR, which is the rate financial institutions use when lending money to one another. Currently, both rates are relatively low, but they're likely to jump by at least 3% in the next few years, says Kantrowitz. Loans with interest rates pegged to the prime rate are somewhat easier to predict. The prime rate is low right now in part because of the Fed's multiple rate cuts in 2008, says Hupalo. With the rate at 0% to 0.25%, there isn't much more room to cut.
Loans pegged to the LIBOR are a different story. In the end of 2008, the LIBOR was rising in part because financial institutions were skittish about lending to each other, says Kantrowtiz. In the past few months, lending hasn't increased but the LIBOR has stopped rising. The three-month LIBOR is currently at 1.23%, down from last year's peak of 4.82%.
If the LIBOR resumes its ascent, student loans pegged to it will see increases in coming months, warns Kantrowitz.