A new report has found that millions of students every year miss out on federal student loans and sign up for much riskier private loans instead – an option that usually brings higher interest rates and fewer safeguards for borrowers.
Oakland-based advocacy group the Institute for College Access & Success says in the report [PDF] that many colleges could do more to help steer students toward the cheaper, safer federal loans for which they're eligible.
The report comes as students at the University of California and California State University saw big jumps in the cost of tuition last week, meaning students likely will look increasingly to student loans to foot the bill.
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"Some colleges are already engaging in practices that help students make better-informed choices about private loans, and all colleges of different types can use these as models to help students in that way," said Matthew Reed, author of the report and program director for the Institute for College Access & Success.
Private student loans generally are considered riskier for students because they have uncapped, variable interest rates as opposed to the fixed rates offered under federal loans. So interest rates can increase over time, as they did for former University of Phoenix student Valisha Cooks, according to her testimony [PDF] before a U.S. House subcommittee last year.
"I paid the interest on my private loans while I was in school, and the interest rates rose by 1% or .5% every single month. That’s when I realized these were not the same as federal loans, but it was too late," Cooks' testimony reads.
Unlike federal loans, private student loans also are nearly impossible to discharge through bankruptcy, and they lack the loan forgiveness programs, deferment options or cancellation rights that are built into federal student loans.
Despite that disparity, out of the one in seven undergraduates who used a private student loan in the 2007-08 academic year, the majority had not taken out all the federal loans for which they were eligible. Almost one in four did not take out any federal loans at all, the report said.
Reed interviewed financial aid administrators at 22 colleges around the country and found that some colleges have successfully decreased students' reliance on private loans. They've done it by identifying and counseling students who have applied for private loans at key moments to educate them about their federal loan options.
The report says the most promising practice is to identify private loan candidates through a process called "school certification," in which private lenders contact colleges before they will issue a private loan so that they can confirm basic information about the student’s enrollment and costs. Although it's voluntary and not required by law, many lenders require school certification to limit their exposure to risk.
School certification also gives colleges an opportunity to reach out to the student and educate him or her about federal loan availability, the report says.
San Diego State University, for example, is cited as a good model. When a private lender contacts the university for a school certification, the college requires the student to go through online loan counseling before it will certify the student's private loan application. The counseling includes information about the differences between federal and private loans and explains that most students are eligible for federal aid.
Preliminary data from San Diego State suggests the process may be cutting down on students' use of private loans; in 2010-11, about half of students who initially applied for private loans chose not to move forward with them, the report said. But the university would need to do more research to understand why students canceled private loan applications, said Chris Collins, associate director of San Diego State's Office of Financial Aid and Scholarships.
Collins said the university began the loan counseling program in spring 2010 because students have increasingly turned to private loans as the cost of attendance has continued to rise. The current price tag at CSU is double what it was in 2007.
But several unnamed colleges interviewed for the report had no such interventions. One large for-profit four-year school and another small nonprofit four-year school generally certify private loans without contacting the students.
Another group of colleges include private loans as part of the initial financial aid award letters they send to students, a practice the report says "conveys the college’s tacit approval of this type of financing, and can give the false impression that private loans are a form of financial aid."
Reed declined to name the colleges with problematic practices.
The report offers several recommendations for colleges, including requiring counseling before certifying private loans, tracking the outcomes of these efforts and refraining from including private loans in financial aid offers.
"It really is good to catch the student right at the point when they’re making the decision. It’s a teachable moment," Reed said.