Private lenders gave out money without considering whether borrowers would repay, then bundled and resold the loans to investors to avoid losing money when students defaulted, according to a study being released Friday.
Those practices are closely associated with subprime mortgages, which inflated the housing bubble and helped bring about the 2008 financial crisis.
Subprime-style lending went to college, and now students are paying the price, said Education Secretary Arne Duncan, whose department produced the report with the Consumer Financial Protection Bureau.
Duncan said the government must do more to ensure that people who received private loans enjoy the same protections as those who borrow from the federal government.
Student loans fall into two main categories: Loans directly from the government and those offered by banks and other private financial companies. The report focused on private student loans, which spiked from $5 billion in loans originated in 2001 to more than $20 billion in 2008. After the financial crisis, as lending standards tightened, the market shrank to $6 billion in 2011.
A report by The Education Trust in 2010 showed students who attend for-profit colleges rely heavily on private loans to help cover the cost of their education. The report showed that 46 percent of students who attend for-profit colleges took out private loans, compared to 25 percent for private non-profit institutions and 14 percent for public institutions.
The new study says American consumers still owe more than $150 million in private student loan debt. Including federal loans, Americans now owe more than $1 trillion in student loan debt, according to the CFPB. It has surpassed credit card debt as the biggest source of unsecured consumer debt.
Private student loans are riskier than federal loans, the study said. They often carry variable interest rates, which can cause monthly payments to rise unexpectedly. Federal loans offer fixed interest rates.
In many cases, if a borrower is unable to repay, federal loans can be postponed or reduced. Those options are rare for private loans, the study said.
Students often did not understand the difference between federal and private loans, the study said. That caused many to take out costly student loans when they were eligible for cheaper, safer government loans.
A graduate of the University of Idaho earlier this year responded to a request for public comment on private student loans. The student, whose name was redacted from the public comment document, had left the U of I in 2002 with no student loan debt, thanks to scholarships and the generosity of my parents. But the graduate went on to law school in Washington and finished with $150,000 in student loan debt, about half of which was private student loan debt through the lender Access Group.
The monthly payments for the student's debt totaled $1,500, later refinanced to about $800 a month for the private loans and $300 a month for federal loans still more than 25 percent of the graduates monthly income.
These payments are killing me, the commenter said, adding that theyre also hampering the graduates ability to buy a home, have a baby, buy consumer goods and save for retirement.
The study highlights a unique feature of student debt: Unlike credit card balances and most other debt, it is nearly impossible to cancel student debt by filing for bankruptcy. That leaves many borrowers trapped, behind on loans that lenders are unwilling to modify, the study said. There are more than 850,000 private loans in default, worth more than $8.1 billion, it said.
Too many student loan borrowers are struggling to pay off private student loans that they did not understand and cannot afford, said Richard Cordray, director of the Consumer Financial Protection Bureau. The CFPB was created in the wake of the financial crisis to protect people against unfair loans, unexpected fees and other financial threats.
Lending standards for private student loans were loose during the credit bubble of the mid-2000s, the report said. Because private lenders marketed directly to students, schools did not review borrowers financial needs or enrollment status. As a result, many borrowed far more than they needed to pay for tuition. The loans went to people with increasingly weak credit scores, making repayment less likely, the study said.
The report is based on data from nine lenders on more than 5 million loans made between 2005 and 2011, as well as data from five nonprofit lenders.
The Idaho Statesman contributed.