Private Student Loan Debt: the Newest Lending Crisis?

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In recent years, lenders have dished out private student loans to borrowers they knew could not repay their student loan debt, according to a new government study. The risky lending has forced this type of loan debt to balloon over the past decade, leaving some to compare it to highly-criticized subprime mortgage lending.

Private Student Loan Debt Soars

A new report released by the Consumer Financial Protection Bureau (CFPB) and the U.S. Department of Education revealed that student loan debt associated with private student loans has increased significantly over the past decade.

Private student loans fall into one of the two main categories of loans issued to students who need financial assistance with college tuition, fees and other payments. The second category, federal student loans, is most utilized by students because it offers access to lower interest rates and more flexible repayment options.

Experts typically recommend that students take on private student loans as a last option. However, a growing number of students who haven’t been able to qualify for federal loans have turned to private loans, despite often being unable to repay them.

As a result, consumers owe more than $150 billion in private student loans, contributing to the $1 trillion owed in total student loan debt.

Private Student Loans Compared to Subprime Mortgages

One issue the CFPB report found with private student loans is their likeness to subprime mortgages. Many students don’t understand the difference between private and federal loans. They fail to realize that the private loan option often comes with variable interest rates that fluctuate. Also, that private loans usually aren’t deferred, despite financial hardship.

The report suggests that some lenders took advantage of students’ lack of knowledge by issuing large loans they knew borrowers could not repay then bundled and resold the loans to investors to avoid losing money when students defaulted, a similar strategy to subprime mortgage loans issued prior to the financial crisis.

Student Loans

Encouraging students to take larger-than-needed loans was especially hurtful because student loan debt, unlike most other types of debt, is nearly impossible to have waived when filing for bankruptcy. Currently, the study found, there are more than 850,000 private loans in default, worth more than $8.1 billion

Arne Duncan, Secretary of Education, announced the need to change the rules for private student loan borrowers. He said the government needs to take action so that borrowers of private student loans benefit from the same protections as individuals who borrow from the federal government.

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