National Student Centre

Responding to pleas from student aid officers and lenders, the U.S. House of Representatives voted late last month to postpone a series of auctions for PLUS Loans for parents and to allow guarantors to sell rehabilitated loans to the Education Department, helping thousands of borrowers escape default.

The changes, which are included in a “technical corrections” measure that fixes minor errors in last year’s bill to reauthorize the Higher Education Act, now head to the Senate.

Passage of the technical corrections bill came only two days before lenders were to submit their initial bids to participate in the auctions, which would award two year contracts to lenders that agree to accept the lowest subsidy rates to make PLUS Loans to parents. If the state-by-state auctions are successful, the Education Department will announce two winners for each state by April 24.

Under the PLUS Loan program, parents can borrow up to their child’s cost of attendance, minus any student aid received. Interest rates, currently ranging from 5.01 percent to 8.5 percent, are typically lower than those for private loans.

Student aid administrators and lenders have repeatedly urged the department and Congress to delay the auctions, warning that they could fail in states with relatively small loan volumes. Colleges’ fears deepened in recent weeks as Sallie Mae, JPMorgan Chase, Nelnet, and other large lenders announced that they would sit out the auctions altogether.

On another front, the bill would permit the Education Department to purchase rehabilitated loans that guarantee agencies have been unable to sell to lenders. That change would allow thousands of borrowers who had defaulted on their loans but made nine on time repayments to wipe their credit histories clean.

Guarantee agencies have struggled to find buyers for rehabilitated loans for several months because of the freeze in the market for student loans. While some guarantors have been able to sell their rehabilitated loans to affiliated agencies, including state based secondary loan markets, 19 of the nation’s 35 guarantors have no buyers for their loans.

The freeze has created problems for borrowers because rehabilitation is not complete until the loan is sold. Without buyers for the loans, some 15,000 students a month have been left in legal and financial limbo, unable to put their defaults behind them.

High interest rates and tough payback rules could leave your student out on a limb.

UNTIL A YEAR OR TWO AGO, private student loans (not to be confused with federal student loans offered through private lenders) were the hottest thing on campus since sliced pizza. The number of private loans more than tripled between 1998 and 2008, rising from 7% of all educational loans to 23%. Then credit seized up and dozens of lenders left the market. Now, the lenders who continue to offer the loans have made them more expensive and harder to obtain.

That isn’t necessarily a bad thing. Unlike federal loans, which carry fixed rates and flexible repayment terms, private loans carry variable rates, which typically end up in double digits. They offer little relief for borrowers who have trouble repaying, and they let students borrow relatively high amounts, making it easy for them to get in over their head.

Lesson? Have your student max out on federal loans first and use private loans sparingly, if at all. New rules from the Federal Reserve, which take effect in early 2010, dictate that lenders must disclose more and better information about interest rates and fees. In the meantime, here’s what you should watch out for:

To cosign or not to cosign. Your student will need not only good credit but also a creditworthy cosigner usually a parent to get a private loan. Lenders look for a score of at least 680 on the part of the student (or no credit score at all), and 700 to 720 for the cosigner, says Kevin Walker, of SimpleTuition.com. If you cosign, you are on the hook if your student is late on or misses a payment.

Study Interest rates. Lenders peg the interest rate for private student loans to the prime rate or the LIBOR index, plus a margin, which depends on the applicant’s and the cosigner’s creditworthiness. Pay attention to the highest advertised rate, not the teaser, says Tim Ranzetta, of Student Lending Analytics, an independent research company. The average starting rate, including the margin, on private student loans has been running about 11%, he says, but variable rates tend to go up, not down. Figure the rate will rise by about four percentage points over the life of the loan.

Compare total costs. Also vet the fees and find out when and how often interest is added to the principal, both of which affect the total cost of the loan. The annual percentage rate wraps those factors, along with the interest rate, into a single number. But keep in mind that the APR reflects the cost over the intended life of the loan, and doesn’t let you compare the costs of loans with different repayment periods. Also, the APR changes depending on whether the student is in school or in repayment, so be sure to check both numbers.

Shop the lenders. Applying for too many loans over an extended period can hurt your credit score. Select the most promising four or five lenders and apply to all of them within a 30 day window. To start, ask the financial aid office at your student’s school whether it provides a list of preferred lenders. Compare lenders and loan terms at FinAid.org, SimpleTuition.com and StudentLending-Analytics.com.

The Education Department is releasing data today on the percentage of students at more than 5,000 colleges and universities who defaulted on student loans over a three year period.

The data, which are preliminary, appear consistent with a congressional report out in August showing that students who took out federal loans to attend for profit colleges have higher default rates than those who attended public or private non profit schools.

Colleges where default rates are too high can become ineligible for federal student loans and Pell Grants.

Under current law, sanctions are applied based on two year default rates, typically published each September. The Education Department calculated three year rates to help schools prepare for a change in federal law that goes into effect in 2014, says Dan Madzelan, acting assistant secretary for postsecondary education. Under the new law, colleges with three consecutive years of default rates of 30% or more can be sanctioned.

No college will be penalized based on today’s release of three year rates, which for many schools are higher than the two year rates. “This is purely information,” Madzelan says. “We think it is a good idea for institutions to begin to understand what the change … means for them.”

Terry Hartle, a lobbyist with the American Council on Education, cautions that default rates “are not good indicators of institutional quality.” But, he says, “As students accumulate ever higher levels of debt, it is important that they have access to this information.”

A number of studies show that low income students and those from families who lack higher education are more likely to default on their loans. Student loan defaulters “can tarnish their credit reports, make it difficult for them to obtain employment, and jeopardize their long-term financial well being,” says an August report by the U.S. Government Accountability Office, the investigative arm of Congress.

Default rates for institutions, along with information about the percentage of students who borrowed, will be available at about 11 a.m. ET today at www.fsadatacenter.gov.

Debbie Cochrane, program director of the non profit Project on Student Debt, urges consumers to consider the data in context. “A 30% cohort default rate (has a) very different (meaning) at a school where 90% of students borrow compared with a school where 5% borrow.”