Private Student Loans: The Subprime Mortgages of the College World

Student loans and student debt
With more than $1 trillion in student loans outstanding, many students and graduates are struggling under the weight of huge amounts of debt. But as a report from the Consumer Financial Protection Bureau reveals, one fairly small part of the student loan market appears to be most responsible for many of the problems borrowers face: private student loans.

According to the CFPB report, borrowers have more than $150 billion in private student loan debt. Yet the market for private student loans is still a pretty small niche, making up just 7% of total student loans originated in 2010-2011.

But go back a few years, and you would have seen a much different story. During the mid-2000s, investor demand for securities backed by private student loans led to a big growth surge in lending activity. Just as subprime mortgages opened up the housing market to less creditworthy borrowers, so too did lax lending standards for many private loans sow the seeds for trouble later on, with students taking out loans they didn't need and borrowing more than they could afford.

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The CFPB report points out some of the consequences. More than 850,000 loans have defaulted since 1999, involving more than $8 billion in debt. Because private student loans don't come with the same deferment, forbearance, and debt forgiveness options that many government loans have, borrowers have a lot less flexibility in handling problems once they arise. Moreover, even bankruptcy isn't a good option for troublesome private student loans because of tighter bankruptcy laws governing courts and their ability to discharge student loan debt.

For-Profit Problems

The report notes the big role that for-profit colleges have played in boosting private student loans. Citing 2008 statistics, 42% of undergraduates at for-profit colleges used a private student loan, compared to just 14% of undergraduates overall.

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Private Student Loans: The Subprime Mortgages of the College World

Many school districts are desperate for teachers to work in low-income schools or to teach in high-demand programs. In return for teaching for five years, college graduates may be able to get large portions of their loans forgiven. The exact payoff depends on the type of loan, but the benefits can be huge: Stafford loans may qualify for up to $17,500 in repayment, while Perkins loans may qualify for full forgiveness.

Facing huge amounts of student loan debt? Eager to see the world? Desperate to fill out your resume? Look no further! The Peace Corps will cancel up to 70% of Perkins student loan debt. When it comes to Stafford and consolidated loans, the deal is not quite as good -- the Peace Corps will allow full deferment for up to 27 months, but won't pay off loans. Right now, though, spending a couple of years filling out a resume and waiting to enter the job market could be a very attractive option!

For new grads who are interested in volunteering, but aren't interested in traveling halfway around the world, Americorps and VISTA could be attractive options. VISTA places volunteers with nonprofit groups, while Americorps places them in a variety of jobs, from teaching school to environmental cleanup. In return for a one-year stint, workers in both programs get stipends of up to $7,400, plus $4,725 to pay off loans.

The military offers some outstanding education resources, including the Montgomery GI Bill, which can cover more than half of the cost of a college education. For graduates facing heavy loan debts, the Army National Guard has some particularly nice options, including the Student Loan Repayment Program, which will pay up to $50,000 worth of student loans, depending upon the student's area of study.

Love working with animals, but hate being in debt? The Department of Agriculture's Veterinary Medicine Loan Repayment Program may have the answer: Qualified applicants may receive up to $75,000 in loan forgiveness -- $25,000 per year for up to three years. The only catch is that you'll probably have to get used to living in the boonies -- participants are placed in areas that have insufficient veterinary coverage.

Veterinarians aren't the only ones who can benefit from loan forgiveness -- the government also offers some great loan forgiveness options for human doctors. Health care professionals looking to have the Northern Exposure experience might consider working with the National Health Service Corps and the Nursing Education Loan Repayment Program, both of which place medical workers in underserved regions.

Nor are small towns the only place where doctors can get their loans paid off. The National Institutes of Health will repay up to $35,000 per year in loans for qualified clinical researchers, and many hospitals will help repay loans for doctors who agree to work in physical therapy, among other career tracks.

As many young law school grads have been discovering, a Juris Doctor degree is not the moneymaker it once was. Luckily, some states, including Maryland, offer loan repayment aid for state employees who have studied law. For that matter, there are several programs that will help pay off loans for lawyers who work with nonprofits or public interest groups.

If worst comes to worst, you could always try escaping from your loans by literally escaping. The French Foreign Legion, for example, not only offers the opportunity to go to foreign lands, but encourages new members choose a new identity. Enlistment is for five years, and new enlistees receive roughly $1,400 per month. After serving one stint, legionnaires may apply for French citizenship, an option that may give you legal protection from your creditors, in addition to a pretty sweet state-run universal health care system.

But the report doesn't call out all private student loans. As the Education Finance Council noted in its response to the study, the CFPB found that default rates on nonprofit, state-affiliated lenders are about half those of for-profit lenders.

Despite recommendations from the CFPB to make the private loan process more transparent and easy to understand for prospective borrowers, the real challenge comes from rising college costs. As long as young people need a college education in order to succeed, demand will keep prices high and drive many students into credit problems that will take them years to overcome.

For more on education and your money:

Motley Fool contributor Dan Caplinger only spent a modest amount of his loan money on pizza. You can follow him on Twitter here.

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