Students Paying Outrageous Rates for Private Loans

Private student loan interest rates can be as high as credit card rates. For example, J.P. Morgan Chase & Co. charges as much as 10.25% annual interest on student loans. Unlike the federal student loan program, which allows consumers to borrow at fixed rates directly from the government, these loans from at least 30 banks and other private lenders are mostly variable interest rates that can be more than double what people pay in the government program.

With college costs increasing, the marketing and interest rates of these private student loans are drawing increased complaints from borrowers and regulators, who say that the primarily teenage consumers do not understand the loan terms. Loans from banks and other private lenders make up approximately 15% of the $1 trillion in outstanding student debt, according to an estimate from FinAid.org, a website about college grants and loans.

About 2.9 million students have private loans according to the most recent federal data. With college costs continuing to soar, companies such as Discover and SLM (also known as Sallie Mae) are both working to expand their student loan businesses. However, in April JPMorgan, the largest U.S. lender by assets, said it would stop offering student loans as of July 1st except to bank customers.

To pay for college students typically rely on fixed-rate goverment-backed loans. These loans currently carry interest rates from 3.4% to 6.8% but are capped at $31,000 for a dependent student's undergraduate career. Parents can also take out federal loans at 7.9% up to the cost of attendance less any financial aid.

Private loans are often used to bridge the gap between the cost of college and what a student can take out in federal loans. However, private loans do not offer students the same protections as federal loans, such as income-based repayment plans and deferment. Private loans also are not guaranteed by the government. Private loans can carry higher interest rates because students often do not have a credit history.

At the same time lenders are charging students high interest rates, banks such as JPMorgan have been able to borrow from the U.S. Federal Reserve at close to 0% since December of 2008. The central bank, whose target for overnight interbank lending is 0% to 0.25%, has said economic conditions will probably warrant keeping it low through at least 2014.

A significant amount of the outstanding private student loan debt was amassed before 2008 when credit standards were not as strict and lenders targeted the education market through direct marketing to students. Private student loans peaked at $22 billion in the 2007-2008 school year, according to The College Board. At that time approximately 14% of undergraduates took out private loans according to a 2010 report from the U.S. Goverment Accountability Office. Annual lending dropped to about $6 billion in 2010-2011 as lending standards tightened and federal loan limits increased.

More than two thirds of borrowers with private loans who took part in an online survey said they did not understand the main differences between private and government loans. A bill introduced in the Senate in March would require colleges to counsel students about taking out the maximum in federal loans before venturing into the private market.

Sallie Mae has said it will adjust the terms of private loans for certain customers when it determines the changes may increase a customer's ability to make payments. Options can include reduced payment plans, lower rates or extended terms and temporary suspension of the requirement to make payments.

Students are relying more on student loans as the cost of tuition rises faster than the pace of inflation. Average tuition and fees to attend a public, four-year college were $8,244 last year, almost triple the 1995-1996 cost of $2,811. At private schools they have more than doubled to $28,500 from $12,216, according to data from The College Board. The figures exclude room, board and other costs.

Sallie Mae says it is trying to increase its lending to students. The company's private loan portfolio was $37 billion in the first quarter, which was about the same as in 2009. The company said in April that it expects to write about $3.2 billion in private loans this year, which is down from $7.92 billion in 2007.

Currently 88% of Sallie Mae's outstanding private loans carry rates below 10%, while half are at less than 6.75%. Sallie Mae says it works with customers to help them navigate the loan process, advising that rates are disclosed multiple times during the application process and by offering rate reductions to customers who make small payments while in school. In May Sallie Mae said that it planned to offer its first fixed-rate student loans, with interest rates ranging from 5.75% to 12.875%.

Discover bought Citigroup Inc.'s private student lending business in 2010 and $4.2 billion of the bank's private student loans. It purchased an additional $2.5 billion of loans in 2011. In May Discover said it would offer a fixed-rate, private student loan with interest rates from 6.79% to 9.99%, depending on the borrower's creditworthiness and if there is a co-signer.

As a reminder, student loans generally cannot be discharged in bankruptcy. Therefore, if you are considering taking out student loans I would encourage you to first exhaust your federal student loan options before considering a private student loan. Also, please be sure to carefully review the interest rate and repayment terms. If you are having trouble paying your other bills due to student loans, you may want to consider filing bankruptcy to eliminate other unsecured debts, which would free up cash to timely repay your student loans. I can help you file bankruptcy in Kansas or Missouri and I offer a free initial consultation. I welcome any questions or comments.