Private Loans: Still the Most Dangerous Form of Student Loan Debt

At a time of low interest rates, our guard may be down when it comes to the dangers of taking out private student loans. After all, families with excellent credit may be able to obtain loans with interest rates lower than those available in the federal loan program.

Perhaps that helps explain why more than 40 percent of college admissions directors who responded to a recent Inside Higher Ed survey said that it was “a good idea for students to take out private loans to pay for college.” More than half of the admissions directors at private baccalaureate colleges who were surveyed agreed with that statement.

But hopefully those admissions directors will read a report that the Consumer Financial Protection Bureau released this week that reminds us that private student loans remain the most dangerous form of loan debt that students can borrow to pay for college.

Here’s why:

  • Unlike federal loans, private loans generally have uncapped interest rates that vary month to month based on market conditions. As a result, borrowers may start out with low rates, only to find years later, that their payments have skyrocketed. In addition, while federal loans offer the same terms to all borrowers in a given year, private lenders tend to charge higher rates to those with the greatest financial need.
  • Private loans lack basic consumer protections that are available in the federal loan program. Borrowers with federal loans who become unemployed or suffer economic hardship, for instance, have a legal right to have their loans deferred for several years. Private loan borrowers who run into trouble don’t have that option. And unlike federal loans, private loans generally are not discharged if a borrower dies, is permanently disabled, or attends a school that unexpectedly shuts down before that student completes his or her studies.
  • Private loans also lack the flexible repayment options that the federal loan program offers. Private loan borrowers, for instance, can’t make payments that are based on their income.
  • Unlike the federal student loan program, borrowers can be put immediately into default if they miss a single payment on their private loans. In the federal loan program, a borrower has to be delinquent on their loans for at least 270 days before they are considered to be in default.
  • As the CFPB found in an earlier report, private loan borrowers who are making their payments on time may automatically be put into default if the co-signer on their loan dies or files for bankruptcy.
  • Despite the CFPB’s prodding, private loan providers generally refuse to modify the loans of borrowers who are in financial distress. Those who run into trouble typically are given only one option: a short-term forbearance. And to add insult to injury, struggling borrowers often must pay the lender a fee of approximately $50 to obtain the forbearance, which may last as little as three months.

So even though we are in a period of low interest rates, students should remain cautious before taking out a private loan. These loans lack so many consumer protections that they should be used as only an absolute last resort by borrowers who fully understand the consequences of taking on this type of debt.

[Cross-posted at Ed Central]

Stephen Burd

Stephen Burd is a senior policy analyst in the Education Policy Program at the New America Foundation.