Private student loans can cause significant problems for borrowers

Instances of college students taking out large amounts of education loans from private lenders have grown significantly in the last several years, and many are facing financial difficulties as a result of this type of lending.

In all, Americans owe more than $150 billion on private student loans, which is problematic because many of the people who carry those balances seem to have a limited understanding of the ways in which they work, according to a report from the federal Consumer Financial Protection Bureau. At the beginning of 2001, lending on this type of financial product amounted to less than $5 billion annually, but grew to a high of more than $20 billion in 2008. It has since receded, however, falling to less than $6 billion in 2011.

But the problem during that period of growth was two-fold, the report said. First, during that time, and specifically between 2005 and 2007, the marketing and distribution of this type of financing to borrowers with subprime credit ratings, and more frequently extended credit directly to those receiving it without involving their colleges or universities. In that two-year period, the percentage of loans made without the school being involved, or even certifying the loan, grew to more than 70 percent from just 40 percent. As a consequence, many borrowers took out more than they needed to pay for tuition, room and board, and other costs.

Second, more student loans are now being extended to borrowers who do not have the credit qualifications on their own to obtain this type of financing, the report said. The extension of this type of credit to subprime borrowers has expanded significantly in recent years, and by 2011, accounted for 90 percent of all private student loans. That's up from 85 percent in 2009, and just 67 percent in 2008. This adds a layer of protection for lenders while still leaving more consumers exposed to the potential for delinquency and default.

Further, it became clear over the course of the investigation into private student lending that many consumers simply aren't made aware of the terms of their financing, and many don't know even basic information about it, the report said. A large number of those who obtained private financing did so before first exhausting the federal Stafford Loan limits they were allowed to meet. Some even noted that they did not know they had fewer repayment options on private financing than they did from federal lending.

Tough job market not helping subprime borrowers
It's no secret that the job market in recent years has been unkind to those who are looking for work, but statistics show the problem is particularly pronounced for recent college graduates, the report said. In 2009, the unemployment rate for private student loan borrowers who began school between 2003 and 2004 climbed to 16 percent, well above the national average. And because private student loans don't have the deferment and other options available through federal loans, this can put recent graduates in rather tricky situations.

In all, 10 percent of recent graduates of four-year schools had monthly loan payments that exceeded 25 percent of their total income, and consequently, default rates have risen significantly since the end of the recession, the report said. The total amount owed on those defaulted balances was more than $8 billion across more than 850,000 lines of credit.

As a result of these findings, CFPB director Richard Cordray has asked that Congress pass laws requiring schools to have a more active role in approving private lending for students, the report said. Further, he asks that lawmakers examine the viability of allowing those filing for bankruptcy to have these balances discharged, which is typically not allowed under current bankruptcy laws. The belief is that doing so will help to make consumers more aware of the differences in cost federal and private lending will carry.

Defaulting on any kind of line of credit can do significant damage to your credit score, but may be particularly problematic for recent college graduates because student loans typically amount to tens of thousands of dollars, in addition to whatever they owe on their other lines of credit, such as auto loans and credit cards. Further, it can imperil their ability to gain financial independence soon after they leave school.

However, if you want to do more to protect your finances, you might want to take the time to order and review a copy of your credit report. Doing so will help you to identify any potentially unfair markings that may be having a negative impact on your credit score. Fortunately, working with a credit repair law firm can help to alleviate these issues and restore your credit rating.