With mortgage defaults surging, more individuals are losing their homes to foreclosure as adjustable rates make individuals unable to pay their monthly payments. The student loan companies are also showing a surge in defaults as unregulated lending practices make students unable to pay their debt. Although the student loan crisis does not seem to have impacted as many individuals as the mortgage loan crisis, many individuals, schools and loan companies are worried about how the current lending practices will affect the student loan industry and the economy in the future.
Adjustable-rate mortgages (ARMs) are the primary cause of the subprime mortgage crisis. When the ARMs' low rates adjust upward, many homeowners need to refinance to fixed-rate mortgages in order to afford the monthly payments. Unfortunately, with homes decreasing in value, many banks are unwilling to refinance because the home lacks equity. Consequently, many subprime homeowners default on their loans.
Student borrowers are confronted with similar problems because many education loans offer a low rate which adjusts rather dramatically after an introductory period. In addition, colleges benefited by taking kickbacks in stock options and referral fees to lure students into taking the loans with low introductory incentives but adjustable rates. Furthermore, unlike homeowners, students can not refinance their student loans and do not have the option to sell their education when payments are too high. Like subprime mortgage holders, students can no longer make payments once loans adjust upward. When the student can not pay for the loan, the loan goes into default.
Historically, students with risky credit backgrounds are encouraged to borrow thousands of dollars to pay the increasingly high price of higher education, despite the fact that graduates are earning less after college compared to the amount they are borrowing. More students are also borrowing from private student lenders, instead of government programs. Furthermore, more students are taking out loans to finance educational related expenses such as a computer, books and clothing, instead of working part time or cutting spending to alleviate some of the costs.
The student loan crisis has not progressed to the level of the mortgage loan crisis and therefore policies are being changed to mitigate some of the effects. The Department of Education is now investigating practices of many private student lenders and may implement some legislation to protect students from misleading incentives. More legislators have been placing pressure on college campuses to increase disclosures and information provided within the loan documents. More colleges and universities are also doing more to make students aware of all the details surrounding student loans. For example, many colleges require the borrower to consult with a financial aid advisor and discuss the terms of the loan before any documents are signed. In addition, companies like Sallie Mae are contemplating changing their selection criteria when students apply for loans. In the future, students may be approved for smaller loans, which could mean that some students may be forced to settle for less expensive colleges.