Ask Money

Student loans

Chris Farrell Nov 26, 2008

Question: No one has yet commented on how the credit crisis is going to affect the availability of college loans. Likely, since it’s still early in the educational year, no problems have been noticed…but what about later? Drew, Carlisle PA

Answer: The credit crunch is having a dramatic impact on the student loan market, although it does appear that most students are getting the money they need at the moment. Companies that lent to students relied heavily on securitizing those loans and selling them into the global capital markets. That business is largely shut down with the credit crunch. Sallie Mae and other student loan companies are struggling. Many financial institutions have stopped making private student loans or consolidating student loans. Compounding the financial pressures on lenders is a recent law that limits federal subsidies to them. Parents are also feeling the pressure since it’s estimated that about a quarter of tuition costs were paid with home equity loans, and that market is drying up too.

I think the Department of Education has been a government backwater during the credit crisis. Still, it has enacted several initiatives to bolster the market. Most recently, it said it will support the market by buying up to $6.5 billion in federally guaranteed loans from the 2007-2008 academic year. The Dept. of Ed. is focusing on shoring up the Federal Family Education Loan Program, which accounts for most of the loans banks and other financial institutions make to students. The government also makes loans directly to students. (I expect that this latter program will expand under the new Administration.) A number of universities are dipping into their funds to make loans available.

So far, it looks as if the stopgap measures are mostly working. But there are genuine concerns going forward. The Dept. of Ed is working on a bigger program announced Nov. 8 to buy up more loans, but it will be awhile before it is up and running. It may not be enough, either.

More fundamentally, I think that the student loan boom has gone bust. Government policy, as well as colleges and universities, have come to rely too much on student loans. It’s anecdotal, but I find it fascinating that – judging from the emails we get at Marketplace Money – student loans have replaced credit cards as the main debt worry of young adults. It’s also sinking in that the student loan default rate is much higher than the 4% to 5% level the Department of Education has officially announced for years. For example, reaching back into the 1990s and following student experience over the subsequent years, students with loans totaling $15,000 or more had nearly triple the default rate of those with loans of $5,000 or less–19% versus 7%, according to researcher Erin Dillon of Education Sector, an independent think tank based in Washington D.C.

Finally, if you look at the wages of college graduates in the 2000s they’re either flat or down, after adjusting for inflation, while the real cost of student borrowing has gone up. The college market needs to change: Too much debt, a high default rate, and low wages at graduation don’t add up.

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