The Credit Squeeze and Student Loans
Stories in the media and announcements by some lenders have
led to questions and confusion about the availability of loans for students in
college now or entering college in the fall. Here's the scoop.
What's all the fuss about?
Mostly because of problems in the mortgage market, there was a dramatic decline in the number of investors willing to purchase some types of
financial instruments (especially auction-rate securities). Some student loan
companies have been using these methods of financing to raise money to make
student loans. Some banks sell their loans to companies that used these financing methods. With the unexpected loss of financing, these companies have been forced to stop or reduce their lending.
Changing their financing methods can take time, especially because no one is quite sure what financing models will succeed in addressing investor nervousness, and when.
What does this mean
for students and their parents?
For federal loans, which is the type most people have even
if the loan comes from a bank, everyone will get the loans they are eligible
for. The biggest issue that some will experience is that the lender they used
last year is not making loans this year. In those cases, students will have to
choose a different lender.
What if students can't
find a lender willing to make a federal loan?
That's highly unlikely, and the federal student loan program
already includes safeguards to take care of that problem if it were to occur. There
are more than 2,500 lenders in the system, and only a few dozen have announced
changes in policy. Banks like to make student loans because the loans are
guaranteed by the federal government -- there's no danger that the loan won't be
paid back, even if the economy gets worse and the borrowers are unemployed. That
makes federal student loans an especially desirable investment in today's shaky
That said, the current lack of liquidity in the credit markets, if it goes on for too long, will effect more and more lenders. Fortunately, Congress has taken action to provide liquidity to the federal student loan program by allowing the U.S. Department of Education to purchase loans made by banks. Furthermore, if an eligible student at an eligible school can't
get a federal loan, there are intermediaries empowered to make "lender of last
resort" loans. In addition, students and parents can get the loan funds
directly from the federal government through their school's participation in the Direct
In short, while some
lenders are scrambling to fill a financing gap, the system is quite secure for
students. That's why we can say with confidence: everyone who qualifies for and wants a federal student loan will get
What about students
who need private student loans?
About eight percent of undergraduate students take out private
or state-sponsored loans that are not federally guaranteed. Most of these loans are to borrowers with
good credit records: they are not likely
to experience any problem in getting an education loan, though, for the reasons
described above, some of the lenders they have used in the past may no longer
be making loans, at least temporarily. So they may have to switch lenders, and
the interest rate might be a little higher.
Students or parents with no credit history or a poor credit
history will have more difficulty getting a private student loan than they did
in the past. This may be especially true at technical schools with low
graduation and job placement rates. To address this gap, Congress has increased the amount that students may borrow in the federal programs.
What should families
do if they're having difficulty getting a private student loan?
See our Consumer Guide: Student Loan Options in a Tight Credit Market.
Families should make sure they are exhausting all of
their federal options. Most parents (even those with no credit history) are
eligible for federal PLUS loans. If a parent's poor credit history makes them
ineligible for the PLUS loan, then the student is entitled to additional
If private loans are the only route, then finding a credit-worthy
cosigner can help a lot. But first make sure that the school is the right fit and
really worth the money. A warning to any
student considering a high-interest-rate private loan for a short-term training
program: be very skeptical of any claims the school makes about your
future job prospects and your ability to pay off the loan. If you have doubts,
seriously consider a different program or a different school.
Also, students should apply for private scholarships that
could reduce the amount they need to borrow.
Are there any other factors
contributing to loan companies exiting the federal loan program?
Until recently, most federal borrowers had interest rates on
their loans that would adjust each year.
In 2002 to 2005, interest rates were at historic lows, and federal rules
allowed borrowers to lock in those rates by taking out a federal consolidation
loan. (The government still pays the lender the higher rate as interest rates
in the economy increase). A number of
student loan companies were created or grew quickly in those years to take
advantage of the billions of dollars of consolidations that were occurring
because of the low rates. However, since
July 1, 2006, rates on new federal loans have been fixed, so the market for
consolidation loans is drying up. In addition, federal subsidies to lenders making
consolidation loans were reduced last fall (subsidies on other federal loans
were also reduced, but not by as much).
Some of the lenders that have announced they will end or
reduce their participation in the federal student loan program had a major focus in the consolidation market.