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The Credit Crisis Goes to College
Upheaval in the student-loan business leaves students and parents scrambling

By Susan C. Thomson

Shayna Murphy was completing summer studies in England when a friend e-mailed her the news: The Massachusetts Educational Financing Authority had just announced that it didn’t have the money to make private, or “alternative,” student loans—the kind that students turn to after tapping out on federal ones. This was MEFA dropping the second shoe, the first one being its exit from the federal loan market in the spring. Suddenly, the agency was effectively out of the business for which it was created.

And 25,000 would-be borrowers—mostly Massachusetts residents or students attending school there—were left with just a couple of weeks to scramble for new private lenders before their fall semester bills came due. Those stranded included about 2,200 students—about one in ten undergraduates—at the University of Massachusetts Amherst.

Murphy, a junior there, was expecting to apply to MEFA for a private loan of $1,800 to $2,000 when she returned and, based on previous experience, get her money in time to pay for fall classes. “It took a while for it to set in for me that this was going to be a big problem,” she said.

While friends easily made new arrangements, the three lenders Murphy applied to turned her down for her lack of a cosigner and credit record. To make camends meet, she doubled up on work, adding a job in a campus kitchen to her existing work-study assignment. Putting in 30 hours a week while taking a full load of classes “makes it difficult,” she said, “but I should be able to pull it together.”

Shayna Murphy, a junior at the University of Massachusetts Amherst, had to double her work schedule after an expected student loan failed to come through.
(Photo by MJ Maloney, Black Star, for CrossTalk)
Murphy and the Massachusetts students were caught up in a particular, and spreading, credit crisis that began well before the current global one became a topic of everyday conversation. Beginning in late 2007, student lenders started playing hard-to-get. By spring 2008, almost every day seemed to bring word of yet another student-loan source scaling back, deciding either to serve fewer schools, or make fewer loans or none at all. The list of the totally or partially disabled swelled to include every type of provider—banks, student-loan companies and non-profit state student-lending agencies.

The agencies of several other states found themselves in the same cash-short bind as MEFA, which got back into private lending in September 2008, after securing $400 million in new bond financing. Its counterparts in Kentucky, New Mexico, Illinois and North Carolina managed to provide uninterrupted service by also issuing bonds. Unable to get any financing, those in Pennsylvania, Texas and Michigan suspended lending altogether.

As academic 2008-09 began, 130 lenders, including 27 of the industry’s 100 biggest-volume originators, had folded their federal-loan businesses. In addition, 31 providers had quit offering private loans. (These counts come from Mark Kantrowitz, who tracks the student-loan industry on his website,

Disruptions continued into the fall semester, which found thousands of students waiting weeks for promised loans, or scouring for back-up lenders after their old reliables left them hanging.

In mid-August, Edamerica—a forprofit which counts itself the country’s eighth-largest provider of federal student loans, and the fastest growing of the top ten—notified 200,000 students across the country that it would not be able to pay them right away.

Among those coming up empty handed were 1,500 students at 21,000-student Kennesaw State University in Kennesaw, Georgia. Joe Head, assistant vice president and dean of enrollment services, said the news came just four days before students’ deadline to pay up for the fall semester. About 500 were able to do so anyway, he said. To those who couldn’t, the university offered vouchers for the bookstore, explanatory letters for their creditors, and assurance that their classes wouldn’t be canceled.

For the university, Head said, the delay was “a drag on timely and accurate information” on enrollments, as well as a frustration and inconvenience to many campus offices, not just student accounts.

It took a month for Edamerica to come through for all of its Kennesaw State borrowers. By then, Edamerica chairman and chief executive Tony Hollin said, the company had worked through virtually all of the $280 million loan backlog with which it began the school year and had caught up with other students and colleges across the country. For the delay, Hollin mostly faults slow disbursements from the U.S. Department of Education, and a 70 percent increase in his company’s loan volume, the result of other lenders quitting the business.

Kennesaw State senior Courtney Ayres watched the situation unfold there from inside the university’s financial aid office, where she works part-time. The staff was inundated with concerned students, some crying, some “rude and obnoxious,” she said. She was upset herself, at first, but then “kind of calmed down” at the prospect of having to wait for the $1,980 loan she needed for health insurance and room and board after she covered her tuition with her federal Pell grant.

Ayres counts herself fortunate to have had enough money on hand the keep herself in groceries during the couple of weeks she had to wait for her loan. Despite the hitch, she expects to continue borrowing from Edamerica, which has otherwise served her well, rather than take her chances with a new lender. “All lenders are going to have their issues,” she said. “I’ve seen a lot of lenders go through a lot of problems.”

Their problems largely trace to those risky sub-prime mortgages and the fancy securities they were bundled into, all of which began souring in mid-2007 and went on to spook the entire global economy. As the crisis deepened, credit markets seized up, and student lenders were among borrowers of all sorts who found their usual money wells shallow or, at worst, dry.

Lenders in the federal loan market took a second whammy from the federal College Cost Reduction and Access Act, which was passed partly in reaction to revelations of shady practices by a few student lenders and went into effect in October 2007. While dropping to six percent from 6.8 percent the maximum interest rate students could be charged on the cheapest federal loans made after July 1, 2008, the measure lowered the subsidies and raised the fees for the lenders. Lower profits, plus scarcer and costlier funds, made for a powerful disincentive for lenders to continue business as usual, or to continue at all.

The result was the most chaotic year for student loans since the federal government got into the business of guaranteeing them for collegians and their parents in 1965. Since then, debt has increasingly become the means to a degree. An estimated two-thirds of undergraduates now borrow somewhere, somehow, to finance their educations. They have no choice, as family incomes and money available as grants or scholarships that don’t require repayment have failed to grow in synch with the escalating cost of college attendance. Last year, students borrowed nearly $66.7 billion in the federal governmentbacked loans alone, an inflation-adjusted increase of 70 percent in a decade, according to the College Board.

However, the federal government lets students borrow only up to certain prescribed limits. From time to time it raises them, but recent increases have lagged behind rising college costs, forcing more students into more private loans to cover their widening budget gaps. Students took out $19.1 billion in private loans last year, up from $1.3 billion in 1997, when the College Board’s annual report on college financial aid first took note of that emerging market.

Sometimes dubbed the “wild west” of student lending, the private market is a catch-as-catch-can place where borrowers are on their own to find lenders and negotiate terms. While federal loans are fixedrate, private loans are generally of the variable type, their rates fluctuating over time and depending on market conditions and borrowers’ credit-worthiness.

As Shayna Murphy discovered to her chagrin, qualifying for a private loan these days can be problematic, as straitened lenders, even those who never made subprime mortgage loans, have hunkered down into defensive mode and raised the bar for borrowers.

Parents Susan Jones Knape and Patricia Bromfield, though eventually successful in securing private college loans for their children this year, also attest to private lenders’ newfound caution.

For Knape, a Dallas marketing executive, the entire process of applying for financial aid for two freshman daughters (Jordan and August) at the same time was so “mind-boggling” she had to “stop a couple of times and have a margarita.” Finally, with federal loans in place for Jordan at Pratt Institute in New York and for August at Southern Methodist University, she applied for private loans for both girls. The bank she found required her co-signature on a nine percent note for August and a 12 percent one for Jordan. With regard to the three-point difference, the only explanation Knape can imagine is a ding on Jordan’s credit report because she had once reneged on a contract with a gym.

Patricia Bromfield, an information technology specialist in Joliet, Illinois, has had two years of even more puzzling experiences with private loans. Her daughter, Nicole Worthem, now a sophomore at Benedictine University in Lisle, Illinois, got one on just her own signature for the first semester of her freshman year. Second semester, the same lender required a cosigner and accepted Bromfield. The rate both times was an “astounding” 14.25 percent, Bromfield said, but the lender was easy to work with.

Not so for Nicole’s second year, when the same lender demanded two cosigners. At that, mother and daughter—separately, together and with other possible cosigners— began applying to “everybody and anybody” for a private loan. Ultimately, the originator of Nicole’s federal loans came through with a private one at 10.25 percent, with Nicole’s boyfriend serving as cosigner.

Bromfield is mystified about why this year’s rate is lower than last year’s, and why the lender allowed the boyfriend, who has no credit history, to cosign. She dreads next year, when Nicole’s twin brother, Nicholas, now attending community college on minimal federal loans, expects to transfer to a four-year school. She just hopes it won’t be a private one.

“This loan situation is getting to be a nightmare,” she said.

Courtney Ayres, a senior at Kennesaw State University, in Georgia, was one of the 200,000 students whose student loans for the 2008-09 academic year were delayed by Edamerica, a major student loan provider.
(Photo by Robin Nelson, Black Star, for CrossTalk)
To James A. Boyle, president of the 95,000-member College Parents of America, the loan situation is, at root, a college-pricing problem. “Colleges are raising their price because they can, because there’s a large cohort of students coming through high school,” he said. “Couple that with the fact that there are more families that recognize that a college education is important to success…There’s a strong demand for seats in college, and there’s a fixed supply, and that causes the price to go up.”

Boyle’s prescription is for colleges to rethink their financial aid policies and limit the merit aid many use to attract better students, a practice that only raises the sticker price for all, he said. “There needs to be greater emphasis on need-based financial aid.”

Meanwhile, quicker, smaller fixes for lenders and borrowers are already in place, the results of the Ensuring Continued Access to Student Loans Act of 2008. To lenders, the law extended a helping hand in the form of a promise that the federal government would buy from them all federal student loans they could not otherwise sell to raise capital. Originally due to expire in mid- 2009, the offer has since been extended for an extra year.

The pledge is widely credited for keeping a worrisome situation from worsening, by keeping federal student-loan money flowing, even if haltingly and through fewer lenders. “It helped avert a crisis by providing liquidity to the education lenders,” Mark Kantrowitz said.

Borrowers received two immediate and permanent favors from the same act, both portending to make them less dependent on expensive private loans: The act raised the borrowing limits on federal student loans by $2,000, and it improved the terms on federal parent loans.

Now, for the first time, parent borrowers can postpone repayment on their loans as long as students remain in school, just as they have long been able to do with private loans. Parent loans already had the additional advantage of coming with a fixed rate, now 8.5 percent.

Although that might be higher than some initial rates on variable-rate private loans, parent loans are now the better long-term option, according to Beth A. Post, financial aid director at the State University of New York at Albany. So this year the university is showing parent loans as pieces of students’ aid packages and advising applicants about them.

Sandy Baum, a professor of economics at Skidmore College, and a senior policy analyst specializing in college aid for the College Board, welcomes the new parentloan provision. “There has always been a big question of why it is that parents who would be eligible for parent loans are having their students go instead to the private loan market, where rates are higher,” she said.

“In some cases it’s because parents feel it’s the student’s responsibility to pay for their college education,” and they hesitate to take on debt of their own, said Carolyn LeGeyt, senior associate director of financial aid at Trinity College in Hartford, Connecticut.

Financial aid adviser Maria Gadberry counsels one of the 1,500 Kennesaw State University students whose Edamerica loans were delayed this fall.
(Photo by Robin Nelson, Black Star, for CrossTalk)
Susan Knape didn’t hesitate, but in applying for a parent loan, she ran up against their chief disadvantage: In contrast to federal student loans, approval isn’t automatic. Rather, just like private student loans, federal parent loans require a credit check, and in today’s harsh credit environment lenders have grown more picky about granting them. Given her good job and what she thought was flawless credit, Knape expected to qualify. So she was “flipped out” when she was rejected. Investigating, she found that a former creditor had reported a dispute they had had to a credit agency but neglected to note that a settlement had been negotiated. After that one disappointing try, she gave up on private loans altogether.

While the student-loan crunch played on with no end in sight, the 2008 presidential campaign played itself to a close without education issues catching more than the glancing attention of the parties and candidates. Of the two major parties’ platforms, only the Republicans’ specifically mentioned student loans, urging simplification of the current “Byzantine” system, but offering no specific suggestions.

On the campaign trail, John McCain vaguely pledged to fight to make student loans more affordable. Barack Obama came out for a gradual switch to “direct lending” of federal loans and elimination of the prevailing system, by which student loan companies, banks and state agencies make these loans, and the government guarantees them.

In doing so, he was endorsing an idea that originated in the administration of George H.W. Bush—that it would be cheaper, faster and simpler for students to draw their federal loan money directly from the federal government rather than through financial middlemen. After President Bill Clinton enthusiastically took up the cause, direct lending began in 1994 in a small way, with about 200 colleges and universities taking part, and accounting for just four percent of federal student loan dollars.

Three years later, hundreds more schools had signed up, and one-third of federal loan volume was flowing through the direct program. Then, over the next decade, direct volume dwindled, little by little, to 19 percent of the total.

The growth stalled chiefly because of opposition, and then competition, from the banking industry, which managed, even as direct lending began, to persuade Congress to put limits on it. The argument against it was a classic free-market, antigovernment one—that students would be best served by a marketplace where multiple providers contended for their business.

That indeed proved to be the case, according to many financial aid officials at schools that use the traditional federalloan system, some after trying direct lending and finding it wanting. Students have benefited, they say, as lenders vied with one another to offer the best rates, repayment options and service. Plus, Jane M. Hojan-Clark, director of financial aid at the University of Wisconsin-Milwaukee, said many families appreciate the option of picking their lenders, perhaps ones with whom they already have a comfortable relationship.

In the past year, though, tight money and margins have left federal lenders little room to cut deals, and their service has turned spotty. Meanwhile, “the Department of Education has proved more reliable than the banking community” in delivering federal loans, said Martha Harbaugh, financial aid director at Maryville University in St. Louis. For 12 years, she added, direct lending has worked so smoothly there that students aren’t even aware of it.

David Wiggins, a senior history major at the university was aware only that his federal loan money had always come through without a hitch, but he had “no clue why.” After direct lending was briefly described to him as a possible reason, he grinned. “That’s awesome!”

After a “mind-boggling” experience trying to find student loans for her two daughters, Dallas marketing executive Susan Jones Knape finally secured a private loan at 12 percent interest for daughter Jordan (above) to attend Pratt Institute in New York, and a nine percent loan for daughter August at Southern Methodist University.
(Photo by Lisa Quiñones, Black Star, for CrossTalk)
The U.S. Department of Education had counted, through mid-September, 400 schools switching to the direct program in 2008. They include returnees Michigan State University and Indiana University Bloomington, and newcomer Pennsylvania State University. Recruits also include a number of community colleges and small private colleges cut off by lenders because their loan volume was too low, said Roberta Johnson, director of student financial aid at Iowa State University and chair of the National Direct Student Loan Coalition, whose member schools use and advocate the direct approach.

More schools are considering it. Given its experience with Edamerica, Kennesaw State University will probably look into direct lending, according to Joe Head. A committee at SUNY Albany is studying a switch, having been through “a processing nightmare” with lenders this year, Beth A. Post said. “I can’t imagine a student keeping track of what they’re supposed to understand and what they’re supposed to do.”

Will Shafner, director of business development for the Missouri Higher Education Loan Authority, cautions that direct lending is not as glitch- or cost-free as it might first seem. That’s because the Education Department hires private vendors to administer the program. “They’re paying somebody to answer the phones and process all of those applications,” he said. And with “more schools panicking and signing up,” he predicted that contractors will not be able to handle the extra volume.

A College Board-sponsored report on student financial aid, published in September, takes no sides in the debate over how best to deliver federal student loans. Though largely a plea for streamlining delivery of federal grants, the document argues briefly for lifting federal loan limits as a way of reducing students’ “excessive reliance on alternative loans with less favorable terms and without the borrower protections provided by the federal government.”

The National Association of Student Financial Aid Administrators also has “concerns” about private loans, especially the “predatory” marketing practices of some lenders, said president and chief executive Philip Day. As remedies, NASFAA supports raising federal loan limits and increasing federal Pell grants in order to “minimize student debt.”

For harried borrowers, the immediate prospect is for more of the same. Although federal-loan money is abundant and readily available, the financial gobetweens that arrange the loans are not, meaning borrowers may have to work harder and longer to get the money they need.

For the higher-cost private loans, the search could be even more difficult and, at worst, futile. That’s because these loans are in the same leaky boat as consumer loans in general, subject to prevailing credit conditions. Mark Kantrowitz foresees slim pickings “unless the capital markets recover.” What’s more, interest rates are rising on the private loans still out there.

As a new student-loan cycle for another school year begins amid continuing uncertainties, Day offers this practical advice for loan-seeking students and parents: “Don’t wait till the last minute to line up your financial resources. Get in and talk to the financial aid professionals…and let them work with you,” he said. “The sooner people do that the better off they are.”

Susan C. Thomson is a former higher education reporter for the St. Louis Post- Dispatch.

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National CrossTalk Fall 2008



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