Student-Loan Woes Hurt Upper Middle Class

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Problems in the student-loan market are especially hurting upper-middle-class families whose children won't go to the local community college, but are not quite up to snuff for the Ivy League.
The tight credit markets are making private student loans more costly and difficult to obtain, with several major lenders stepping out of the fray. Wachovia (WB) became the latest major bank to cut back on undergraduate loans last week. It follows Citigroup (C), which took similar steps earlier this year, along with Bank of America (BAC), JPMorgan Chase (JPM) , Student Loan Xpress (owned by CIT Group (CIT)) and a slew of others.

Kevin Walker, CEO of SimpleTuition.com, says the number of companies offering loans on the site has dropped dramatically to about 22 today from about 77 at this time last year. He says about 20% of those enrolling in higher education—or about 3 million students—seek out private loans to fill in the gaps left from scholarships and limited state and federal support.

Those who will be hit worst by the student-loan crunch will be students whose parents don't earn enough to pay the escalating cost of enrollment. The problem will be particularly acute for students entering schools that have high tuitions, but don't have large endowments to entice them to come.

"It's not everybody," says Walker, "but it's people who go to high-profile schools - great institutions that don't have the deep pockets that Princeton has."

Even before the credit markets began to tighten up last year, Walker says private student loans were made "almost exclusively" to prime borrowers. Students without cosigners, or those with cosigners whose credit scores were below 650 have always had a tough time getting approved.

"These loans were not subprime," Walker says.

But in today's market, regardless of how credit-worthy the borrower is, lenders and investors have little appetite for unsecured debt that has a 2-, 3- or 4-year lag in repayment. During that time economic conditions –and family finances—can change dramatically.

Today's market can be summed up in the recent results of Student Loan Corp.(STU) , whose chief shareholder is Citi. The company posted a 40% drop in second-quarter profits as it increased reserves for loans that may go bad—despite the fact that private student loans are generally offered to prime borrowers who repay their debts.

The company faced higher costs for acquiring the capital, as well as a tough market for re-selling its bundled loans, since investors today are more skittish about such unsecured debt. As a result, Student Loan Corp. boosted the fees for those making payments, more than tripling its "fee and other" income to $39 million from $9.4 million.

In other words, students (and their parents) are paying the price of the current credit-market malaise, regardless of how credit-worthy and responsible they are.
Walker emphasizes the fact that there are still private lenders offering loans, and some have not yet restructured rates to reflect current credit conditions.

"It's a dramatic difference from this year to last year—that's the bad news," says Walker. "The good news is that there are still [some] out there who feel that they can get to more borrowers than they could in a more competitive market."

Students should consult their institution's financial-aid office—which knows best what options are available—and hurry to secure an aid package before those lenders boost rates or exit the student-loan market as well.

And remember, there are no four-year guarantees. Private lenders don't often make commitments beyond the current school year, meaning that students and parents could be in for a tougher—and more expensive—slog ahead in obtaining education financing going forward.

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