Student Loan Defaults on the Rise
How to ensure you don’t become the next statistic
First it was the student loan scandal, which revealed that lenders were illegally paying off college financial aid officers, and resulted in a tightening of student loan requirements and higher interest rates. Then the flailing economy led to increased unemployment and decreased financial stability. So it’s not entirely unsurprising that more college graduates are beginning to experience difficulty paying back their student loans.
“I hear a lot of rumbling in the student loan industry; a lot of people are really nervous,” says Paul Simino, CEO of OneSimpleLoan, a student loan financing and consulting firm. “Many people are predicting that the default rates will go up. It’s inevitable.”
In the aftermath of the credit crunch, lenders like Sallie Mae are becoming especially cautious. They’re now viewing certain student loans as risky investments. In fact, Sallie Mae recently announced plans to restrict or cut back on providing loans to students with poor credit scores. Tightened student loan restrictions may result in a one percent hike in private student loan rates, as well as requiring a minimum 650 credit score, up from 620, according to FinAid, a popular Internet financial aid resource. In addition, the minimum balance for loan consolidation will likely increase to about $10,000, and many loan discounts will likely be cut.
The student loan cohort default rate, the rate at which students default on their loans within the first two years after graduating, is expected to rise. While student loan cohort default rates are historically low at 4.6 percent according to figures provided by the U.S. Department of Education, there’s a push to recalculate cohort default rates using a 36-month window instead of the current 24-month window, since defaults tend to increase over time. Proponents of the Grijalva/Bishop Amendment to the Higher Education Act, as it is known, say that the extra year will give a better picture of the number of student loan defaults. But the move will likely increase the student loan cohort default rate, too, and make certain schools lose their Title IV eligibility, meaning their students would no longer qualify for federal Pell grants as a penalty for having a higher percentage of students going into default.
Research now, save big later
What effect will all this have on you? If you’re an incoming freshman or a new grad school student next fall, it pays to do your homework, says Jacqueline King, assistant vice president of the American Council on Education. “The same way it pays to shop around for a good mortgage, you need to really shop for loans.”
It used to be that only graduate students took out large loans, King says. “These were the folks who borrowed a lot, but would make a lot, too.” But as tuition keeps rising, it’s becoming increasingly common for undergraduate students to take out student loans, too. They’re also borrowing more; the average college senior’s debt load for the 2003-2004 academic year was $19,237, up from $11,400 in 1997..
At the same time, the amount students are eligible to borrow through federal loan programs, which tend to offer lower interest rates, had not increased in years and only recently increased modestly. Such stagnancy has a greater number of students turning to private student loans, which carry higher interest rates. That’s because they need to borrow more than the $23,000 Federal Stafford loan lifetime limit for dependent undergraduate students, which currently carry a 6.8 percent interest rate. Private student loans, which supplement federal loans, currently average 10.8 percent interest.
As a result of the student loan scandal, financial aid officers may be reluctant to help you choose between lenders for fear that their integrity may come into question. “That’s why it’s going to be even more important for parents and students to do their homework,” King says.
Shop smart to avoid default
The way to prevent student loan defaults, experts say, is to shop around for the best student loan terms and be cognizant of just how much you are borrowing. Before signing the dotted line, you must calculate just how large a monthly student loan bill you’ll have to pay – and whether you will be able to afford it.
“Look at the interest rate and see whether it’s fixed or variable,” King advises. “In many cases it will be variable. So you’ll need to look at the underlying method of calculating that rate.”
Common traps include low introductory rates and hidden fees. Also, check out the prepayment terms for potential penalties.
Before turning to private loans, however, make sure you’ve first borrowed the full amount of federal loans for which you qualify. “A troubling minority are not borrowing through federal programs at all,” says King. “Private loans often have a much simpler application process. But this is of great concern.”
Most importantly, stay in school. Most students who default on their loans failed to complete their studies, according to FinAid. Many of these students dropped out of vocational and certificate programs in low-paying fields like cosmetology. Although the loans are often not that large, those who don’t graduate often don’t secure a large enough income to pay back the loans. “If you’re going to borrow, finish your degree,” King says.
Delaying default
If you fail to make a payment on your student loans for 270 days, your loans will officially go into default, explains Mark Kantrowitz, a noted financial aid and college planning expert who publishes FinAid.org. This means that your loans will go to a collection agency. Your professional license may be revoked. You will no longer be eligible for deferments. And your credit record may be tarnished, making it more difficult for you to take out a mortgage or even sign up for another credit card, he adds.
Don’t think that bankruptcy will prove an easy way out. Effective October 1998, student loans are generally no longer dischargeable in bankruptcy.
Instead, if you’re struggling to pay back your student loans, your best bet is to get in touch with your lender as soon as possible. “Contact your lender early and often if you know you’re going to be in trouble,” Simino says. “Lenders don’t want you to go into default. You don’t go to the doctor once you’ve been sick for months. You go when you’re just starting to feel sick.”
First, find out whether you qualify for a hardship deferral or forbearance. “This can buy you some time,” says King. If not, request that your lender work out a gradual repayment plan, in which you lower your monthly payments until you are able to afford to pay more each month. This will increase your interest costs over the long-term, so it’s important to increase your monthly payment amount when your income eventually rises.
If you’re a teacher, in the military, or a volunteer, research the possibility of public service loan forgiveness programs, for which the government will cancel all or part of your student loans. Certain doctors and lawyers may also qualify.
In Sept. 2007, the College Cost Reduction and Access Act was signed into law, along with an Income-based Repayment program. Beginning in July 2009, a borrower’s loan payments will be limited to 15 percent of the adjusted gross income that exceeds 150 percent of the poverty line, as applicable to the borrower’s family size. Federal student loans for those who earn low incomes may be cancelled after 25 years.
In short, shop wisely for student loans. If you’re already in repayment, be in touch with your lender to agree upon a reasonable repayment schedule that will prevent you from going into default. And don’t forget to search for other ways to reduce or cancel your debt load.
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