Just how unjust has the student loan-industry become? Consider the following story.
I recently heard from a woman who’d borrowed $24,000 toward the cost of an MBA program she completed a few years ago. The loan—which came from a prominent private lender—was, not uncommonly, structured as a variable-rate transaction, where the interest rate on which her monthly payments were based was subject to change throughout the term of the agreement.
The woman encountered her first obstacle when she asked to have the loan’s future installments lowered after she paid down a sizeable portion of her principal. Much to her disappointment, the lender was only willing to shorten the duration of the loan, which meant that going forward, her payments would continue as before.
Most people would not have had an issue with that. After all, the shorter the term of the loan, the smaller the total amount of interest that ends up being paid.
What the MBA had in mind, though, is a strategy known as loan recasting, where the original amortization schedule is modified to reflect a change that occurs after the transaction is underway. Although it’s in the lender’s interest to accommodate that type of request (because of the extra income it stands to earn over the loan’s longer term), operationally speaking it can be a pain in the neck to implement. That’s why few lenders go along with it.
As frustrating as it was to go back and forth with several different loan-servicing reps, her exchanges led to an unsettling revelation.
The Fine Print
The underlying mechanics of variable-rate loans hinge upon three components: the index that governs the base interest rate, the margin (spread) that’s added to it and the frequency of the adjustments that ensue (e.g., monthly, quarterly or annually).
The borrower’s loan document designated the one-month LIBOR rate as the official index—a basis that’s commonly used for these types of transactions. It also stipulated that the adjustments would occur monthly if the base rate changed in between payments. Although not unusual, the potential for 12 payment changes each year can wreak havoc with even the most well-managed household budgets.
More disconcerting, however, was the manner in which the lender depicted the margin.
The spread was properly referenced within the context of the promissory note, but its value wasn’t quantified. Instead, the borrower was directed to a specific disclosure statement that was supposed to accompany the note; a document that—according to the grad—never found its way to her mailbox and ended up forgotten.
Until she looked again at her promissory note.
The way the agreement reads, the lender has the ability to raise (or lower) the amount of the margin added to the base rate at different points in time and/or under different circumstances—whether or not the contract is in default.
What’s the point of agreeing to a loan where the fundamental pricing methodology can be changed by the lender and where the borrower’s only recourse is to pay it off in full should the result not be to the borrower’s liking?
So the alum pressed the loan-servicing representative to disclose the value of that interest rate mark-up. Otherwise, how else would she know if she was being properly charged? Unbelievably, it took weeks for her to find that out, which she did only after doggedly questioning several reps—who all claimed they didn’t know, because her rate was constantly changing—and escalating the matter many levels higher. Only then did she learn that that margin was 4%…at that particular moment.
Add It to the List
The list of known student loan industry excesses seems to be growing longer with each passing day.
For example, some borrowers aren’t informed about their eligibility for certain government relief programs. Instead, the loan servicers shunt them into negatively amortizing deferments and forbearances that end up exacerbating their already tortured financial circumstances.
Payments are routinely misapplied, including those that were specifically designated to pay down principal balances.
Standard loan agreements are determinedly one-sided: Borrowers must waive their right to a jury trial in favor of arbitration (which is probably the reason we haven’t seen class-action suits), fees are credited before the interest and principal that diminishes their indebtedness, and cosigners remain on the hook for longer than they were led to believe would be the case.
Meanwhile, profitability levels have skyrocketed. And yet student borrowers keep coming back for more.
Perhaps it’s because they don’t know any better. Or maybe it’s because they and their families have been conditioned to gratefully accept what they get from the limited number of lenders that are willing to provide the education financing they need.
Either way, these loan agreements are ticking time bombs—and not just for the borrowers. True, student loans are nearly impossible to discharge in bankruptcy. But when all the negative headlines finally converge and legislators realize they can no longer bob and weave their way past the collective outrage of their constituents, discharge will be the least of the lenders’ (and their shareholders’) concerns.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.
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