Factors Lenders Consider in Making Lending Decisions for Private Education Loans
GAO-10-86R, Nov 17, 2009
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Over the past few decades, the cost of tuition, room, and board for undergraduate students has increased, making it more difficult for some students and families to afford the cost of college. While students have historically relied on federal loans and grants and family contributions to pay for college, a growing number have turned to private education loans to help them cover the cost. In 2007-08, private loan volume, including private sector and state sponsored loans, totaled $19 billion, up from $3 billion in 1997-98, according to the 2008 College Board report on student aid. Unlike federal loans, private education loans are not guaranteed by the federal government and are typically more costly for students than loans offered through federal programs. Despite their generally higher cost, about 26 percent of students who obtained private education loans in 2007-08 did not obtain Federal Stafford loans, and more than one-half of these students did not apply for Federal financial aid, according to the Institute for College Access and Success. In 2007-08, 14 percent of undergraduate students obtained private education loans, according to the Institute for College Access and Success, and the average private loan amount was $6,533. This letter discusses GAO's work under the mandated study in section 1122 of the Higher Education Opportunity Act of 2008 (HEOA) directs the Government Accountability Office (GAO) to assess the impact of private lenders' use of nonindividual factors--factors other than the borrower's own credit worthiness, such as the cohort default rate or graduation rate of the school the student attends-- in making loan decisions. To address the issues raised in the mandate, GAO framed its study around three key questions: (1) What are the key characteristics of private education loan borrowers and the types of schools they attend?; (2) How do lenders use nonindividual factors--including cohort default rate, graduation rate, and accreditation--in making lending decisions for private education loans?; and (3) What is the impact of using these factors on loan products and rates students pay and their access to loans, by gender, race, income, and institution type?
Specifically, according to NPSAS, nearly one-third of the students at the highest cost institutions ($25,000 or more per year) took out private loans. In addition, while students attending proprietary schools accounted for approximately 10 percent of the undergraduate population, over 40 percent of them borrowed private loans. Moreover, a slightly higher percentage of dependent undergraduate students borrowed private education loans (15 percent) compared to independent students (13 percent), and a higher percentage of dependent students from middle and high income families (17 percent and 15 percent, respectively) borrowed private loans compared to dependent students from low income families (about 12 percent).9 In addition, a slightly higher proportion of female students borrowed private education loans (about 15 percent for females and 13 percent for males). While there were varying differences in the percentages of undergraduate students borrowing private education loans by race/ethnicity, Black or African American students were the highest percentage of borrowers. Students who attended certain types of schools were more likely to take out private loans; and in addition, there were small differences that were statistically significant for private loan borrowers with respect to dependent and independent students, family income, gender, and greater differences between some race and ethnicity groups. Private lenders may use nonindividual factors to select the institutions at which they will lend to students and to establish loan terms and conditions, including interest rates, according to lenders and industry experts. Lenders generally view longer programs of study, high graduation rate, and low cohort default rate as more favorable conditions when making lending decisions, according to experts and lenders we interviewed. Lenders, researchers, and industry experts confirmed that lenders have historically used nonindividual factors to help them make lending decisions, especially because students often lack sufficient credit history upon which to base decisions. The student loan lending landscape has changed significantly since the HEOA, which mandated GAO's study, was passed. Many of the lenders offering private loans have exited the market in response to limited access to capital resulting from the credit crisis, according to researchers, lenders, and experts we interviewed. In 2008-09, the private loan volume totaled about $12 billion, according to the 2009 College Board report on student aid. Lenders who have continued their private student loans programs reportedly tightened their lending practices, which have limited some students' access to these loans, according to some researchers we interviewed.