Personal student loans are about to make a big comeback

Recent government analysis has shown that about a quarter of all government grants go to students attending private, for-profit colleges, even though these students make up only 12 percent of the national college population.

Private student loans are non-government loans — student loans made by banks and private lenders, not the federal government.

Private student loans are credit-based loans with variable interest rates that can be up to three to five times the federal student loan fixed rate. Additionally, private student loans generally do not offer the flexible repayment options and hardship protections for borrowers that federal education loans offer.

The recent significant decline in the issuance of private student loans can be attributed in part to a greater awareness of the disadvantages of these loans compared to government student loans.

Consumer advocates, student groups and the US Department of Education have campaigned heavily over the past three years to promote the benefits of low-cost federal college loans over private loans, which the groups claim are more expensive and riskier for vulnerable student borrowers, many of whom do are financially inexperienced and may not be fully aware of the type of long-term debt they are incurring.

Private student loans will skyrocket at for-profit colleges The student loan default rate among for-profit college students is exceptionally high because these students — a large proportion of whom are low-income, minority, or returning students — tend to have a harder time converting their for-profit degree into a into employment, and they have far more student loan debt than their income can pay back after graduation.

New proposed federal financial aid rules aim to curb what critics of for-profit colleges see as runaway student debt by introducing a loan default threshold that would disqualify a for-profit institution from offering federal financial aid to its students if its students have a persistently high level Default rate on student loans.

A proposed federal “employment rule” would also withdraw federal financial aid from for-profit schools whose students graduate with excessive debt-to-income ratios and generally cannot find work — “employment” — that allows them to earn enough to pay off their student loans.

But in the absence of government financial assistance, private loans remain the funding choice among college students — especially in the current economy, where home equity, credit card lines, investments, and college savings are largely depleted — and some private lenders are poised to step in to fill the gaps the layoff has left federal funding with non-eligible institutions.

Major private student loan lenders such as Wells Fargo and Sallie Mae will reap the benefits of proposed government financial aid sanctions set to take effect in 2012, analysts say.

The ongoing recession is forcing students into more expensive private student loans However, the resurgence of private student loans will not be limited to for-profit colleges. The rise, fall, and resurgence of private student loans as part of long-term financial support for US students is directly related to rising college costs and the failure of federal financial support to keep up with the increases.

“Increases in college costs are the leading drivers of increases in student borrowing, particularly when need-based grants do not keep pace with higher college costs,” Mark Kantrowitz, editor of FinAid.org, told Reuters.

And the longer the economic climate lasts, the greater the need for students to find funding sources to finance their studies.

Publicly funded colleges and universities suffer from a range of spending cuts on higher education and pass these losses on to students in the form of tuition and fee increases.

“Private student loan volumes could see double-digit growth over the next year as government budget constraints increase tuition,” said Michael Taiano, financial analyst at Sandler O’Neill.

At the same time, a record number of students are pursuing higher education, enrolling, or re-enrolling in colleges and universities, straining the federal budget for financial assistance.

“Federal budgets are constrained by how much aid they can provide,” said Matt Snowling, an analyst at FBR Capital Markets. “So the financing gap is closed by private loans.”

As the top lender to federal college loans, the federal government is also beginning to see firsthand the impact of a growing number of loan defaults as a national population amid a recession and 10 percent unemployment struggles to keep up with its monthly bills.

New graduates leave school with record high levels of debt and diminished job prospects. Parents who in other years might have helped their children pay for college are turned down for federal parental loans because they have joined the ranks of the unemployed and their own credit ratings do not qualify them for the loans.

All of these factors are opening the door again for personal loans, despite federal government efforts to steer families away from private student loans to government financial aid options.

FinAid.org’s Kantrowitz predicts that private student loan volumes will exceed federal loan volumes by 2025. And, as in the past, private loan lenders are poised to close the growing gap between the cost of college education and the value of a federal financial assistance package.

Personal Loans, The Student Debt Project, Employment Rule