June 1, 2008
College students and their parents are scrambling to line up student loans for the fall amid fears that the broader credit crisis might put the squeeze on such lending.
How bad could it be? That depends on what kind of loan you're looking for.
Late last month, the Bush administration took a big step toward heading off problems with federally guaranteed student loans made by banks and other private-sector lenders. Using authority recently granted by Congress, the federal government plans to purchase and invest in such loans, freeing up capital so lenders can make new loans.
But this initiative -- which will last only one school year -- isn't a fix-all for a complex loan market that is hard to sort out even in the best of economic times. For instance, loans not backed by the government could still be in short supply.
Here's a guide to the different kinds of student loans:
Backing from Uncle Sam
The federal government is the biggest player in the market, having made or guaranteed about $109.4 billion in student loans during the 2007-2008 school year. The debt includes Stafford loans for undergraduates, PLUS loans for parents and graduate students and consolidation loans for graduates who want to combine and refinance previous loans. Borrowers get these federal loans through one of two channels.
Under the "direct loan" program -- which accounted for about 16% of federal student loans during the current school year -- students and families borrow directly from the government, with colleges doing some of the initial paperwork.
The catch is that your college has to participate in the direct loan program for you to apply. About 1,050 schools are active direct loan schools; another 800 or so have direct loan authority but don't use it.
The direct loan program has not been in jeopardy during the current credit crunch. In fact, seeking certainty for their students, more than 280 schools have applied to join it this year.
The concerns have revolved around the government's other lending channel, the Federal Family Education Loan Program, or FFELP, which is used by about 4,500 schools. About 7.5 million borrowers took out more than $91.8 billion in FFELP loans during the current school year.
Under FFELP, banks and other private-sector lenders make the loans and the government guarantees up to 97% of their value, so that a lender takes on very little risk if a borrower defaults. To encourage lenders to take part, the government also pays them a subsidy on each loan.
Those subsidies have been one source of trouble. Last fall, Congress cut them roughly in half, in the aftermath of ethics scandals and investigations involving lenders' financial ties to schools.
While their profits from subsidies were being clipped, lenders were facing problems on another front. Most FFELP lenders package some or all of their student loans into securities that they sell to investors, which generates cash they can use to make more loans.
In normal economic times, those so-called asset-backed securities, or ABSs, seemed like a good investment bet given that they contained student loans guaranteed against default by the U.S government.
But in recent years, lenders have also been marketing ABSs containing subprime mortgages made to borrowers with poor credit histories. As that market collapsed in a wave of foreclosures, investors began backing away from all kinds of ABSs, including those containing FFELP loans.
Help for FFELP
Early this year, lenders large and small began either curtailing or ending their participation in FFELP, saying they could no longer make such loans at a profit. SLM, commonly known as Sallie Mae and the nation's largest student lender, was threatening to pull out of FFELP but opted to remain after the Bush administration unveiled its liquidity plan on May 20.
Most observers think the plan will stem the exodus of FFELP lenders and ensure that there won't be any major shortages of those loans for the fall.
Areas of Concern
The biggest area of concern for the fall is alternative student loans, which don't involve the federal government and are strictly between the borrower and the lender.
Though they typically involve higher interest rates and fewer consumer protections, alternative loans have taken off in recent years as lending limits on some federal loan programs have failed to keep up with college costs. Families took out an estimated $17.1 billion in alternative loans in 2006-2007, up from $1.57 billion a decade earlier, according to the latest figures from the College Board.
Like FFELP loans, many alternative loans are packaged into ABSs, for which there is little demand. In April, Bank of America, a major lender, said it would stop making alternative loans.
Some people believe the government's plan to buy some FFELP loans from lenders will reassure private investors and make them more likely to buy ABSs containing government-backed and maybe also private student loans.
Meanwhile, the private lenders have been tightening credit standards and boosting interest rates.
Credit agencies rate consumer creditworthiness on a 300-to-850 point scale known as a FICO score. Mark Kantrowitz, publisher of FinAid.org, a financial aid Web site, says borrowers with scores in the 620-point range used to be able to get an alternative loan. This year, some lenders will require at least 700 points, he says.
In hard economic times, foreclosures and bankruptcies could also create problems for parents trying to land a federal PLUS loan, which involves a credit check. And parents accustomed to tapping into home equity lines of credit to help pay for college may have to seek other sources, such as alternative loans.
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