Fed-loan limits force higher rates on some
Nelly Perry went to massage school convinced she could avoid the tens of thousands in loans her friends amassed at traditional universities.
She followed the advice of counselors at two schools, borrowing more than $12,000. The process was so easy that she applied for one loan over the phone. But, unlike her friends' loans from the federal government, Perry's came from private lenders charging interest rates of between 8.5 percent and 13.5 percent. Plus, the loan terms required repayment while she was still in school.
"I got overwhelmed," said Perry, 27. When loan collectors began harassing her about missed payments, she moved back home to Milwaukie, Ore., and sought help from a credit counselor. "You feel like there's a ton of bricks on you. You feel like you can't breathe."
With the cost of higher education skyrocketing and federal student loans capped at 1992 levels, more students are turning to private loans to pay for trade schools and even traditional colleges. The loans are the fastest-growing type of student aid, and lenders are scurrying to cash in on the highly profitable products, offering easy online access or jockeying to get on a school's list of preferred lenders.
The trend alarms financial aid advisers who fear students are unwittingly taking on too much debt. Some, like Perry, eventually fail to repay the loans on time. That trend could worsen if interest rates continue to rise.
In addition, regulators are investigating allegations that some trade schools and their lenders have not adequately informed students about the high interest rates and extra finance charges. Authorities in Oregon, California and Pennsylvania this year probed the recruiting and financial aid practices of trade schools owned by Illinois-based Career Education Corp. The investigations follow complaints from students who said they did not know they were taking out loans with 15 percent interest rates.
Career Education Corp. has said it is cooperating with Pennsylvania investigators but calls allegations by California regulators "grossly exaggerated." Lenders say they follow federal disclosure laws and maintain students simply aren't carefully reading loan disclosures. Nonetheless, the loans worry educators and regulators.
"I've seen interest rates as high as 26.5 percent," said Deborah Godfrey, head of the closed schools and student-tuition-recovery-fund unit at the California Bureau for Private Postsecondary and Vocational Education. "Unfortunately, students are very, very, very poor consumers."
Students are resorting to private loans partly out of necessity. Since the early 1980s, college tuition has risen twice as fast as inflation, yet Congress has not changed the maximum a first- or second-year student can borrow since 1992.
As a result, private loan activity grew nearly eightfold between the 1995-96 and 2003-04 school years, according to a College Board survey, from $1.3 billion to $10.6 billion. Private loans now represent about 9 percent of all student financial aid, the College Board says.
Lenders say a growing number of students don't fit traditional molds that the federal loan program envisions. Forty percent of students attend school part time, up from 28 percent in 1970, said Melissa Bassett, executive vice president of Student Capital Corp., a company launched in June to market private student loans. Other students borrow to attend trade schools that either don't qualify to receive federal aid or charge more than $30,000 per program, far in excess of the annual federal loan limits.
But alternative loans differ significantly from federally backed Stafford and Perkins loans and can carry significantly higher risks.
Federal student loans currently carry interest rates of between 4.7 percent and 6.1 percent. The government can raise them in the future, but never higher than 9 percent.
Federal loans are typically more flexible, offering students a chance to postpone repayment if they return to school, lose their job or fall into financial trouble. They also can be consolidated, after borrowers graduate, into one payment. And federal rules require that applicants be verbally counseled about the loans' interest rates and terms of repayment.
Private student loans, on the other hand, carry adjustable interest rates with no caps. Their finance rates usually start at prime rate, now 6.5 percent, and add zero to 6 percentage points or more, depending on the student's credit rating and whether a relative will co-sign for the loan.