Why Banks Are Bailing on Student Loans

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Banks and other private lenders are saying “no mas” to student loans, making the federal government the de facto college loan lender in the U.S. Why are private lenders taking a hike, and what does that mean to student loan borrowers?

No doubt, there is a seismic shift occurring in the college loan market. According to the College Board, private lender college loans fell by a whopping 52% during the 2008-2009 school year. The College Board also says that U.S. families took out $11 billion in private school loans last year down from $22.8 billion in 2007-2008.

Correspondingly, federally-sponsored student loans rose 15% in 2008-2009, to $84 billion.

Part of the reason that private lenders are bowing out of the student loan market is the tough credit environment. With loads of toxic debt on bank balance sheets, fewer lenders want to take on any more risk, especially in the form of consumer loans.

Also, state funding for college financial aid has taken a pounding in the Great Recession. The College Board says that state appropriations for public college funding has slipped by 5% in 2008-2009 from the year before, and that number is expected to rise. That has led colleges to hike tuition rates to make up the difference making the college funding hill even higher and harder to climb.

Another reason is that the federal government is swinging a sharp elbow in the direction of private lenders. The Obama administration has poured billions into federal student loans, and has taken steps to simplify the financial aid process a big priority for families of college-age kids. As the government takes a bigger role in college lending, more and more private lenders are expected to leave the market altogether.

That should act as a yellow light, if not a red one, to U.S. families looking for financial aid. Having the federal government on the road to taking over college loans if you think it can’t happen, there’s a health care plan many in Washington would love to sell you is a dangerous path to take.

For starters, less competition usually drives prices higher. To keep interest rates down, and the college loan pipeline flowing, Uncle Sam can always turn to the U.S. taxpayer and that would mean even less money for college from tax-ravaged households. Or, the federal government could raise interest rates, knowing that the shrinking private loan marketplace won’t hold it accountable. That’s pretty much the same model used in the public school system. Without competition, public school costs have risen dramatically over the past few decades.

Either way, the money needed for federally-sponsored loans is coming out of your pocket in the form of higher taxes or higher interest rates on college loans.

That’s OK with Wall Street. Banks are only too happy to cede the college loan market to Uncle Sam. And Uncle Sam seems only too happy to take on greater responsibility.

But if only one lending institution the federal government is left standing in the end, it’s likely that U.S. families and college students will learn an expensive lesson that they’ll never forget.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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