AEI Report Urges Private Lenders To Take a Forward-Looking View On Student Loans
Posted By Eliana Osborn on July 6, 2016 at 1:26 pm
It’s no secret: The federal student loan program limits how much you can borrow. When these funds aren’t enough to cover tuition and expenses, other forms of loans come into play. Private loans typically come with less favorable terms and use traditional lending sources such as banks. The number of private loans has increased over the past few years and now makes up 9% of the student loan market.
A new report from the American Enterprise Institute looks at the history of private loans and what the future holds for the industry. Private student loans, like other consumer borrowing, require credit checks and often cosigners. College students generally don’t have an extensive credit history; the point of the loan is to increase later earning potential. The AEI report suggests a switch to forward-looking lending, rather than the current norm.
Some lenders already are exploring alternate credit rating strategies, underwriting with an eye toward potential. Looking Backward or Looking Forward acknowledges the risks inherent in changing lending behaviors. There are also concerns about aligning with fair lending practices when you start predicting what borrowers will best be able to repay. Current practices leave “many students with high potential but a thin credit history and no access to a creditworthy cosigner (and) are not able to get a private loan,” the report says.
Federal student loans are available to virtually anyone, regardless of financial health. Private lenders cannot be so cavalier, doling out funds to all who apply. Current default rates vary by school but the 2014 average was more than 13%. That is a significant level of risk for private investors, even when higher interest rates are charged than on federally backed loans.
Relying on someone else to cosign for a private loan also can be a burden for low-income students. Adults in their lives are more likely to have credit history issues, not to mention their own debts. Reforming this lending market to be based at least partially on potential could have significant implications for students most in need.
According to the AEI report, households with Parent PLUS loans are a good indicator of how the private loan market is looking at credit the wrong way. Low-income borrowers facing the highest costs for college—after other aid is accounted for—were twice as likely to have PLUS loans instead of private ones. PLUS are parent-held federal loans, costlier than those held by students but with less stringent credit requirements.
Skills Fund, Pave, and Climb Credit are private loan lenders singled out by the report for using forward-looking models to determine underwriting. Each consider more than just the student wanting to borrow; the colleges and specific degree programs students plan to enroll in are vetted as well. These players are a tiny fraction of the student loan market, but their success may open doors for further innovation.