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Students Taking Out Private Loans Unnecessarily

Although experts tell students to exhaust all their federal-aid options before considering riskier private student loans for college, a new report shows that nearly one in seven undergraduates across all types of colleges and programs used a private student loan in academic year 2007-08. Unfortunately, the majority of these borrowers turned to private loans before taking out all they could have in safer and more affordable federal loans, including almost one in four who did not take out any federal loans at all.

"Critical Choices: How Colleges Can Help Students and Families Make Better Decisions About Private Loans," was released yesterday by the Project on Student Debt, an initiative of the Institute for College Access & Success, a nonprofit independent research and policy organization, in Washington. It urges colleges to do more to educate students about the availability of federal loans and cautions them about the risks of higher-cost private loans.

With skyrocketing education costs, now at least two-thirds of all students who graduate from four-year colleges use student loans to help cover the cost at some point during their undergraduate careers. The financial-aid system is complex, and students don't always fully understand the implications of taking out one type of loan versus another.

Federal student loans are now made through the U.S. Department of Education's Direct Loan Program. They are available to students regardless of family income and have fixed interest rates.

Private student loans are made by banks and lenders. These loans are typically uncapped, have variable interest rates, and cost the most for those who can least afford them. Private lenders are not required to provide the important borrower options and protections that students have with federal aid, such as unemployment deferments, income-based repayment, public-service loan forgiveness, and cancellation if the borrower dies, is severely disabled, or is defrauded by a school.

To help students make wiser borrowing decisions, the report suggests colleges be more proactive with counseling. Before students can take out a private loan, they must go through a certification process with the college financial-aid office. The report suggests this is an opportune time to inform students about the option of taking out a federal loan, which has more favorable terms. Institutions such as Barnard College, Mount Holyoke College, Grinnell College, and San Diego State University are recognized in the report for providing rigorous counseling to students who wish to take out private loans. The promising practices identified provide useful models for all colleges, regardless of their size, cost, or financial resources, according to the report.

Outreach efforts are needed, the report notes, because students and families who apply for private loans are often misinformed and unaware of the availability and benefits of federal loans and the risks of private loans. Some colleges include risky private loans in students' financial-aid offers, giving the false impression that this type of private financing is a form of financial aid. The report discourages colleges from doing that practice and suggests schools formalize policies and practices aimed at reducing the prevalence of private student loans.

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