By Mark Wallach
Have you ever wondered why students pay such high interest rates to borrow funds for education? If you haven’t, you should. The logical answer is that loans to students with no income are risky. This is completely true. But are private lenders really charging only for the additional risk, or are they also taking advantage of unsophisticated, unsuspecting student borrowers and perhaps not being fully transparent about the rates borrowers may or may not qualify for?
First off, let’s not confuse federal loans with private loans. Federal loan rates are regulated by the government and are fairly disclosed to borrowers. Private lenders, however, charge interest rates that are often significantly higher than comparable rates on federal loans. Furthermore, these rates are not necessarily disclosed in the same transparent manner in which federal rates are disclosed.
Until the recent implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the private student loan industry was largely unregulated. Dodd-Frank, which was passed following the 2008 credit crisis, established a Student Loan Ombudsman within the Consumer Financial Protection Bureau. The ombudsman is responsible for documenting consumer complaints related to private student loans and preparing an annual report for Congress and other political parties with recommendations on improvements that can be made within the private student loan market. To date, the complaints within the ombudsman’s reports have focused on issues related to loan servicing, payment processing, accessing payment history and other issues applicable post loan-acceptance. There are few complaints, however, pertaining to issues related to interest rates and disclosures of the rates during the origination phase of the loan. But are private lenders fairly disclosing their rates?
Take the following experience of a student borrower: following a recent loan application to Sallie Mae, the largest lender of private student loans, the Rate and Fee Disclosure—a document delineating a range of rates that a borrower may receive and the payments associated with each—indicated that the borrower’s fixed rate would be between 5.750% and 12.875%. The borrower was ultimately offered a rate of 8.875%, more-or-less in middle of the range. The borrower had the characteristics of what one would expect of a student borrower—no job, but using a co-signer with an established job, good credit, and earning a six-digit salary. Clearly, this student did not receive a rate anywhere near the bottom of the range disclosed. Which begs the question of how many student borrowers actually receive rates toward the lower end of the disclosed range?
Every point—industry jargon for one percentage—makes a difference. On a $3,000 loan with a fixed interest rate of 8.875% and a deferred payment plan (interest accrues but is not due until after graduation) payable over 72 months following graduation, a typical borrower would pay a total of $5,283. This would include $2,283 of interest. A one point decrease to 7.875% would lower the total payments by $321, thus lowering the interest payments by almost 15% over the life of the loan. Now you tell me if each point matters!