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Private Lenders Should Take the Lead on Student Loan Refi, says CFPB

John Sandman

NEW YORK (MainStreet)—The Consumer Financial Protection Bureau is looking to private lenders to take the lead on re-financing student loans, as borrowers continue to struggle with educational debt. In a request for information last February, the CFPB received more than 28,000 comments suggesting private loan repayment alternatives. Many were concerned about a domino effect, where steep monthly loan payments lead to unwanted career and life choices.

Problems with the loans themselves resist an easy fix. The CFPB found that private loans are generally riskier for the borrower than federal loans, with higher interest rates and few consumer protections. They often lack flexible payment options when borrowers can't earn enough to make minimum payments. There is a dearth of lenders offering lower cost alternatives—and that's the rub, especially for those who have fallen behind.

Also see: Will Student Loan Interest Rates Double?

"There are few options for financial relief for borrowers who are struggling with their private student loans," said Mark Kantrowitz, senior vice president and publisher at Edvisors Network. "Private student loans are not eligible for income-based repayment and forbearance options are limited. These borrowers have been unable to negotiate flexible deferment and repayment options with their lenders."

Among the problems are rules that limit lenders' options, especially accounting rules. "For example, a lender has only 120 days to work with the borrower according to current accounting rules," he said. "Some of the potential accommodations are treated more severely than they should be by accounting rules. Sometimes lenders have more flexibility to grant accommodations if they allow the loans to be charged off first."

Even something as basic as contact between lenders and borrowers can be thwarted by rule -making. "For example, college students are more likely to have a cell phone as their only telephone number," Kantrowitz pointed out, "yet a federal law precludes lenders from making robocalls to cell phones—which would be done to maximize the time a counselor has with a borrower. Counselors have to manually call the number."

Non-bank lenders are likely to cherry pick the most credit-worthy borrowers. Social Finance Inc., a San Francisco-based student loan refinance company and a non-bank lender, looks to refinance loans rather than originate them, but is targeting high-value customers.

"We're looking for graduates who are former students that have existing student debt," said Rob Lavet, Social Finance's general counsel and former general counsel at private student loan provider Sallie Mae. "Our target market would be grad students that have a job, an income and high student debt, primarily federal loans."

Also see: Young Student Loan Borrowers Are Bagging the Home Mortgage and Auto Markets

"We can offer a better deal than the federal government in terms of rates," he continued. "We offer borrowers who meet our underwriting criteria a package that pays off their federal and existing private student loans at a rate as low as 5.49%. Some lenders will do a consolidation on private loans, but we're the first lender to offer to refinance a federal loan at a lower rate. Again, we do this for the graduate borrower, the former student with an income and a good credit score."

Lavet acknowledged that most borrowers who are behind with private loans are extremely jammed up and at least for time being, won't be helped by his company. "Right now we can't address those borrowers," he said. "Because we're raising money from investors, we have to know that these loans will be repaid."

"I think the CFPB would like to see a broader re-finance market," said Lavet. "There are a few new entrants, which is a good thing. You have to remember that there was a big contraction in this market. Most of the lenders that were in this business during the last decade have left. Bank of America, U.S. Bancorp, Citibank, among others, have all exited."

Back in the day, the federal student loan program consolidated and refinanced loans after graduation. "Those options don't exist anymore because of how the federal student loan program changed over time," said Rohit Chopra, student loan ombudsman at the Consumer Financial Protection Bureau. "Six years ago, the most common federal loans had fixed rates a 6.8%. Since then, rates in the overall market have gone down quite a bit while those rates have not floated. On the private loan side, risk is reflected in the possibility that the borrower may not graduate or get a job. These rates are relatively high for a borrower who is 18 when he or she gets the loan."

Also see: Rural Areas Give Incentives to those with Student Loan Debt

"One of the things we've discussed is whether new market entrants have access to affordable capital to lend out that money at affordable rates," Chopra continued. "We are also concerned about the challenge of finding new customers. Net interest margin on these loans is relatively high and that suggests a lack of competition. The inability to refinance and find an affordable payment on a private student loan has been a top concern for many consumers."

But the desire to re-finance exists across the board. "Today there are about $1.1 trillion worth of student loans on the street," Chorpa said. "Meanwhile, many students are looking to take advantage of today's historically low rates and are unable to do so."

Many industry observers say it should fall to colleges and universities to raise lending standards for federal loans—or have Congress create a better, comprehensive refinancing program for both private and federal loans. If Congress or some other agency in the federal government re-visits a solution for troubled loans, could a TARP for student loans be far behind?

Also see: Student Debt Diary: Wait, What was the ROI on my Education?

"There has been some discussion of setting up a capital vehicle like TALF or TARP to make it possible for non-bank lenders to re-enter the student loan marketplace," said Kantrowitz. TALF, the Term Asset Backed Securities Loan Facility created by the Fed in 2008, supported asset-backed securities collateralized by credit cards and student loans. TARP, the Troubled Assets Relief Program allowed, the Treasury Dept. to purchase failing assets from financial institutions threatened by the 2008 credit freeze. While Kantrowitz acknowledged that non-bank lenders are more likely to offer re-finance options, he acknowledged that there had been a shakeout in the industry. He said there were about 60 lenders making student loans prior to 2008 and he estimated that five years later, only a fraction of that number are still in business.

--Written by John Sandman for MainStreet

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