Regulators warn student loan hike could send borrowers to private lenders

Allowing federal student loan rates to double might send borrowers to the private loan market, a domain where lenders have been less willing to restructure excess debt, regulators warned. 

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Federal financial officials on Tuesday encouraged banks that offer private loans to be more willing to work with borrowers to pay down debt, something they have so far been unsuccessful at accomplishing. 

That willingness to work with borrowers may be especially helpful if Congress fails to meet the July 1 deadline to prevent federally backed student loan rates from doubling, a prospect that seems increasingly likely

Should Congress miss the deadline and federal loans become more expensive, "We would expect that the relative attractiveness of private products would increase," said Todd Vermilyea, senior associate director with the Federal Reserve Board's banking supervision and regulation division. 

"We should expect growth in originations," he added.

Other regulators, however, were more skeptical. 

"Some industry observers would guess that the change in the interest rates might be a light tailwind to private loan origination, but I don't expect it to be a huge one," said Rohit Chopra, the student loan ombudsman at the Consumer Financial Protection Bureau (CFPB).

Should private lenders see an upswing, Sen. Tim Johnson (D-S.D.), chairman of the Senate Banking Committee, urged regulators to be on guard. 

"I urge the regulators to be vigilant in monitoring growth in the private student loan market that may result from changes to the federal student loan market," he said. "It is critical that regulators respond quickly to marketplace changes and that consumer protections are safeguarded when demand rises."

Originators of private student loans, which make up just 15 percent of the market, have been less willing to restructure borrowers' debt, even though it may be in the lenders' best interest.

"A restructured loan that's performing is far better for everyone than a severely delinquent loan," Vermilyea said.

Chopra told the panel, "In general, the activity of modifying or restructuring debt that may be in the best interest of the debt investor and the borrower is troublingly low."

The CFPB has pushed for private lenders to allow lenders to restructure or refinance their loans, just as mortgage borrowers can, among a series of other options. 

Regulators were hard-pressed to explain why banks are lagging in restructuring the loans, though suggested that the prevalence of co-signers on private student loans could affect the borrowing rate. Banks may also be preoccupied with addressing other troubled loan areas, they added. 

"It's not clear why this isn't happening more," Vermilyea said. "Our regulatory policy would certainly permit it and even encourage appropriate workouts."

Regulators and legislators on the committee worried that high student loan debt could have a domino effect, preventing people from buying a home and boosting the economy in other ways.  

In May, a CFPB report found the country's $1.1 trillion in total student loan debt could be hurting the economy by as much as a $100 billion.

"There's data suggesting that home ownership is undermined by the growing amount of student loan debt," said Sen. Elizabeth Warren (D-Mass.). 

Warren added complaints about the current federal student loan program, which is predicted to make a $51 billion profit off its loans this year, according to the Congressional Budget Office. 

"This seems wrong to me," she said. "It's time to stop making a profit off our students."

Warren has introduced legislation to allow borrowers of federal student loans to use the same rate that banks borrow from the Federal Reserve: 0.75 percent. 

Students currently borrow at a 3.4 percent rate, but that number is scheduled to double to 6.8 percent unless Congress acts by Monday.

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