Private student loans pose greater risk
Consumer, student advocates worry borrowers uninformed

Correction ran 10/26/2006: Limits on the amount of federal Stafford loans that college freshmen and sophomores can borrow will increase on July 1, 2007. A cover story Wednesday gave an incorrect date for the change.

When Jeremy Hynd graduated from Vanderbilt University in 2004, he applied to consolidate $44,000 in student loans. With interest rates then at record lows, consolidation offered the opportunity to lock in a 2.5% rate for the life of the loan.

But Hynd discovered that $27,000 of his loans weren't eligible for federal loan consolidation because they were private student loans. The rates on the two private loans have since jumped to 8.7% and 11.7%, from 5% and 8%, when he was in school. Hynd, 24, an analyst for Sony Pictures Television in Los Angeles, recently took on a second full-time job so he can pay off his private loans as quickly as possible.

Private loans are the fastest-growing sector of the multibillion-dollar student loan industry. In 2005-06, college students borrowed a record $17.3 billion in private loans, up 913% from a decade ago, according to a report issued Tuesday by the College Board.

At a time when the cost of college is surging and financial aid is shrinking, private loans make it possible for many students to attend colleges they couldn't otherwise afford. But consumer advocates and student groups worry that the growth of these loans could prove disastrous for borrowers who don't understand the risks.

Unlike federal student loans, private loans aren't guaranteed by the federal government. While guaranteed student loans carry a fixed rate of 6.8%, there are no limits on the interest rates and fees private lenders can charge. Some have variable rates of up to 19%.

Once primarily used by graduate and professional students, private loans are becoming increasingly popular with undergrads. Nearly 85% of private loans provided by student lending giant Sallie Mae go to undergraduate students, up from 72% five years ago, says Barry Goulding, a Sallie Mae senior vice president.

While federal Stafford loans are available to all students regardless of their credit history, private lenders check a borrower's credit report before making loans. Students who have no credit history, or poor credit, will typically pay higher rates than those with a good credit history or those with a parent who will co-sign the loan. As a result, the poorest students end up with the most expensive loans, says Luke Swarthout, associate at the State Public Interest Research Groups' Higher Education Project.

"It works entirely counter to our financial aid system, which is intended to provide access and affordability with a particular eye to students who are least able to pay," Swarthout says.

Some major lenders that provide federally guaranteed loans, such as Sallie Mae and Citibank, also offer private loans. Other lenders, such as EduCap, specialize in private student loans.

Behind the rise in private borrowing:

Limits on federal student loans.

The total amount undergraduates who are dependents can borrow through the federal Stafford loan program is $23,000, an amount that hasn't changed since 1992. During the same period, the average annual cost of college tuition and room and board at public, four-year colleges has risen 135% to $12,796 this year, according to the College Board.

In addition to the overall limit, there are caps on the amount undergraduates can borrow each year. On Jan. 1, the amount of Stafford loans college freshmen can borrow will rise to $3,500 from $2,625, while limits for sophomores will increase to $4,500 from $3,500. But that's still well short of the annual cost of attending many private -- and even some public -- colleges.

The amount of aid available for low-income students has also stagnated. The maximum Pell Grant, the most common form of direct federal aid for low-income students, is $4,050, a sum Congress hasn't raised since 2003. The most available under the Perkins program, which provides low-interest loans to students with "exceptional" financial need, is $4,000 a year.

As a result, private loans "have become a necessity for a lot of families," says Jerry Cebrzynski, financial aid director for Lake Forest College in Lake Forest, Ill.

Natalie Jones, a sophomore at Northeastern University in Boston, has borrowed the maximum available under the federal Stafford program, and she also won some scholarships. Still, she fell far short of what's needed to pay Northeastern's $40,000 annual tuition and room and board. In her first two years of college, she's borrowed about $39,000 in private loans.

Because Jones' mother, DeLaine Jones, co-signed for the private loans, the interest rate is 7.25%; without a co-signer, it would have been 8.25%. There's no guarantee, though, that the rate won't rise.

Jones, a communications/business major from Apple Valley, Minn., wishes she could borrow more from the federal program but believes the education she's getting is worth the cost of private loans. "I feel I fit into this school," she says. "I'm proud of the fact that I'm getting a private education.

Aggressive marketing.

A borrower who plugs "student loans" into an Internet search engine will find dozens of links to student lenders. Many of them promise to approve $50,000 or more in student loans in 15 minutes. Others say they can deliver loans faster and more efficiently than the federal loan program can.