Report: Risky private student loans leaving borrowers struggling

By Peter Schroeder - 07/20/12 12:08 AM ET

A new administration report has found that more borrowers are defaulting on private student loans that grew riskier just as sub-prime mortgages did before the financial bust.

A joint report issued Friday by the Consumer Financial Protection Bureau (CFPB) and Department of Education found that student loan debt now tops $1 trillion. Roughly $150 billion of that comes from private lenders that employed increasingly risky lending before the bubble burst, leaving many grappling with large amounts of debt years later.

"Sub-prime-style lending went to college, and now students are paying the price," said Education Secretary Arne Duncan. "We still have some work to do to ensure that students who take out private student loans have the same kinds of protections offered by federal loans."

The agencies recommended that Congress consider ways to make it easier for borrowers struggling with student loan debt. Options put forward by the heads of the two agencies included making it easier for borrowers to discharge the debt via bankruptcy, and to improve the education of potential students on the terms of student debt.

"Too many student loan borrowers are struggling to pay off private student loans that they did not understand and cannot afford," said CFPB Director Richard Cordray. "Moving forward, we must do our best to leave the next generation in a better place than we are today, rather than buried under a mountain of debt.”

Just as lax lending led to a bubble in housing loans, student loan borrowing spiked along a similar timeline. The report found that private student lending grew from less than $5 billion a year in 2001 to over $20 billion a year in 2008. When underwriting standards tightened following the financial crisis, private lending dropped substantially, retreating to less than $6 billion in 2011.

According to the report, private borrowing options for covering college costs tend to be more expensive, carry fewer borrower protections and are riskier than federal student loans.

The report, mandated by the Dodd-Frank financial reform law, also found that about 40 percent of people who tapped private student loans did so before exhausting their federal options — an indication that borrowers might not have recognized the difference between the two products. The report also found that students at for-profit colleges took on a disproportionate amount of private student loan debt, as 42 percent of those students tapped the financial product compared to just 14 percent of all undergraduates at private universities.

Now defaults on that debt are on the rise. According to the CFPB, over $8.1 billion worth of roughly 850,000 student loans are in default, and borrowers are reporting difficulties working with lenders to ease the repayment terms.