Rising Interest Rates and Tougher Standards for Private Student Loans

Aside from raising interest rates, lenders of private student loans are toughening their credit standards. Traditionally a comparatively safe corner of the credit markets, student loans has also been snared by the widening sub prime mortgage crisis. The nation's largest student lender recently announced that it is no longer going to provide private loans to students whose credit ratings are below prime. Private lenders are tightening credit standards and raising their rates. Many parents and students lining up college financing this spring will find fewer companies offering them loans. For private loans, they will find much more stringent lending criteria and higher interest rates accompanied with more fees. Most affected will be the students who use private loans to bridge the gap between tuition costs and low-interest government loans. Lenders are likely to require a credit score of at least 650 to secure a private loan, up from a previous requirement of 620.

Students with no credit history will also run into roadblocks, mainly having to pay a higher interest rate. Their rates will probably rise by half a percentage point to a full point. Unlike federal loans, whose interest rates are capped by law, private loans (offered through banks, credit unions, and other lenders) typically charge the variable rates that are tied to credit scores.

Like mortgages, some student private loans are bundled and sold on a secondary market, where they are used to fund new loans. Some lenders are having a hard time raising enough cash to keep making loans. Unlike with federally backed loans, no one serves as the backstop on possible defaults, so investors worry that these bundles of loans are too risky in the long run. Lenders are also coping with a new law that limits federal subsidies on government-backed loans. As a result, some lenders have scaled back on the types of loans they offer and others have taken more bold action. "Due to the current and unprecedented capital-markets disruption" in mid-February, the Michigan Higher Education Student Loan Authority, a state-run agency, said it would suspend its private-loan program.

According to the College Board, private student loans are the fastest-growing segment of the student-finance market today. Students took out $17.3 billion in private loans in 2005-06. A decade earlier than this, students took out only $1.3 billion in comparison. Of course, a lot of this growth can be contributed to the overall rising cost of college tuition.