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How the Subprime Mortgage Crisis Makes Student Loans Harder to Come By

Jun 16, 2008 Jennifer Williamson, Distance Education.org Columnist | 0 Comments

The subprime mortgage meltdown has had an effect on the educational loan market, and this fall parents and students may find themselves struggling to get the cash they need to pay tuition. 

Students and parents can either borrow directly from the government—an option schools have to sign up for, and not all of them have—or through a private lender offering a federally guaranteed loan.  The federal government guarantees to pay often a bit less than 100% of the amount of the loan if the borrower defaults.  It also pays a subsidy to encourage lenders to participate. This agreement has traditionally ensured banks have very little risk in making these loans, and plenty of incentive.

The direct loan program has not been strongly affected by problems in the larger credit market.  The problem arises with federally guaranteed loans offered by private lenders under what’s known as the Federal Family Education Loan Program, or FFELP.   As a result of the college student loan scandals, in which lenders were found to be giving kickbacks to some colleges for promoting their loans over others, Congress cut the subsidies governments pay to lenders who participate in FFELP in half. 

Around the same time, the mortgage meltdown caused investors to become wary of asset-backed securities.  Most lenders don’t simply lend out money and wait for the returns and interest to be paid back.  Instead, they package multiple loans together and sell them to investors.  These packages are called asset-backed securities.  The bank gets up-front money with which they can make more loans, and the investors get to profit on the interest of the loans.  Lenders package and sell mortgages this way as well as educational loans.  When people started defaulting on high-interest subprime mortgages, investors became wary of all asset-backed securities—including student loans. 

With no investors buying these loans, banks have become more selective about who they will offer them to. The Federal government hasn’t been complacent about the problem.  Recently, Congress granted the government the ability to buy and invest in federally guaranteed student loans offered by banks and lenders—giving these lenders the capital they would ordinarily get by selling these loans packaged as asset-based securities.  But this initiative will last only one school year, and it only affects Federally-backed student loans.

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Students don’t just borrow from the Federal government to pay for college costs.  They also borrow directly from private lenders who offer loans that are not backed by the government.  These private loans often have higher interest rates and less desirable terms than government-backed loans have, but students have had to resort to them more as Federal grant and loan programs have failed to keep up with rising college costs.

The problem is that these loans are often also packaged into asset-backed securities, and investors aren’t buying—so banks aren’t profiting from the loans.   Lenders are cutting back from offering private as well as government-backed loans.  Their credit requirements are becoming more stringent, and parents with less-than-perfect credit ratings are predicted to have a more difficult time securing funding for college this year.

There isn’t much individual parents and students can do to alleviate the problem—even the Federal government may not have the power to resolve the situation entirely.  As a parent or student, your best bet is to keep your expenses down and incur as little debt as possible.  Choose a less expensive school, the school that offers the most grants and the fewest loans in its aid package, and take steps to pay off the loans you have while in college.  If you do, you may find that the credit crisis isn’t as much of a disaster for you as it has been for the rest of the country.

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