CFPB Report Compares Student Loans to Subprime Mortgage Lending

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Building on Boston College campus

A government report shows that students loans were made with lack of regard for the students’ ability to repay.

A government report indicates loose lending practices caused student loan debt to reach dramatically inflated levels in the U.S., leaving many Americans struggling to handle loans they weren’t equipped to pay back. What’s even more ominous, according to the report, is the uncanny parallel between the student lending bubble and the subprime mortgage lending practices that caused the housing collapse.

The study, conducted by the Consumer Financial Protection Bureau in July 2012, found that private lenders gave out money without much consideration for a student’s ability to repay. They then bundled and sold the loans to investors when the borrowers began to default, avoiding serious financial loss.

“Subprime-style lending went to college, and now students are paying the price,” Education Secretary Arne Duncan was quoted as saying in a July 2012 Huffington Post article. Duncan’s department produced the report with the Consumer Financial Protection Bureau.

The CFPB study revealed some disconcerting facts related to student loan debt. Particularly the fact that private loans spiked from $5 billion in loans originated in 2001 to more than $20 billion in 2008. After the financial crisis, the debt dropped back to an improved, yet still high $6 billion in 2011. But does this mean that student loan debt has recovered? Not necessarily. American consumers still owe more than $150 billion in private student loan debt, the study said. When you add in the figures for federal student loans, Americans now owe more than $1 trillion in student loan debt.

Like the mortgage industry, student loans underwent a major borrowing boom between 2004 and 2008, the CFPB report said. Now, however, a large number of borrowers are saddled with debt, finding major difficulty in paying down their student loan balances and having an even harder time qualifying for more credit. As more and more college grads begin to seek housing, this issue becomes all the more critical. After all, with mortgage lenders continuing to tighten credit requirements, an applicant with significant student loan debt or a delinquent account, may not have an easy time securing a low rate mortgage.

The CFPB study concluded that there are currently more than 850,000 private loans in default, worth more than $8.1 billion. Unlike mortgage loans, which can be canceled when filing for bankruptcy, student loan debt is nearly impossible to get rid of. Unfortunately, this leaves many borrowers trapped in loans they cannot afford, and they ultimately get behind on payments, their credit score suffering all the while.

So what’s the solution? The CFPB report suggested some policy changes that could help. Recommendations include helping more borrowers refinance to lower rates and creating incentives for income-based repayment programs.

In July, Congress approved a $127 billion transportation and student loan package to enact changes that were long-championed by the Obama administration. In 2007, Congress agreed to temporarily and gradually reduce the interest rate on federal subsidized Stafford loans from 6.8 percent. Eventually, the interest rate dropped to 3.4 percent in 2011 and was frozen in place, not to be changed until 2013. While it may have been a step in the right direction, some critics argue that cutting the interest rate in half isn’t a viable solution to the problem, since it would only benefit a percentage of new student loans.

Steph Meyer is a contributor to the ForTheBestRate.com Blog and keeps us up to date on interesting happenings within the world of home financing and real estate. She’s got a quick wit and keen eye on making smart financial decisions. My Google Profile+

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