Not long ago, Dana L. Knowles received a notice from Sallie Mae, the servicer of her private student loan. Starting in April, the e-mail said, payments on her $26,000 loan would increase by more than $200 a month.
“I can’t pay this much,” Ms. Knowles says. “A couple hundred dollars might not make much of a difference for some people, but it does for me.”
Ms. Knowles—who earned a bachelor’s degree in Italian from Smith College—works full time as a metadata coordinator for a media company in New York.
But she had trouble finding a job after her graduation, in 2007. She worked mostly part-time jobs for her first few years out of college. She twice entered into forbearance arrangements with the lender, paying only the interest on her loan for six months each time.
Now she must either pay the full amount each month or ask for an extended-payment plan.
Many borrowers with student loans from commercial lenders (banks like Wells Fargo and companies like Sallie Mae and SoFi) find themselves in this situation: struggling with high monthly payments and few options to ease the burden.
More than 850,000 private student loans, worth a total of more than $8.1-billion, have gone into default, according to a July 2012 study from the federal Consumer Financial Protection Bureau and U.S. Secretary of Education Arne Duncan.
While federal student loans have more-flexible repayment options and safeguards to help prevent defaults, private student loans offer lower rates but have a hidden danger: They are easy to get but difficult to refinance.
The inability to refinance or negotiate an alternative repayment plan is the top concern among borrowers of private student loans, according to the bureau’s annual report, which was released in October.
Although the continuing political impasse in Washington certainly impedes efforts to improve the private-loan process, a growing call for an overhaul has drawn attention to the issue in recent months.
Ms. Knowles also has a federal student loan and says she has never had trouble meeting that obligation, because the repayment options are more accommodating. “The experience with federal loans as opposed to private loans is like night and day,” she says.
‘Out of Whack’ Rates
Many students turn to private loans because those arrangements often carry lower rates than those of federal student loans, says Justin Draeger, president of the National Association of Financial Aid Administrators.
The interest rate on federal loans is “out of whack” with market rates because the 3.4-percent federal rate, which is set to double in July, was arbitrarily set, he says. For students who have good credit—or whose families have good credit—private loans may appear to be a better deal.
The disparity in rates, Mr. Draeger says, overshadows the benefits of federal student loans and creates a confusing situation for families, since college financial-aid administrators counsel families to use often higher-rate federal loans as their first option.
Additionally, private loans do not require the approval from an institution and do not have the same lifetime borrowing limits that most federal loans have. While a student must qualify and be approved by the college for a federal loan, the college might not know that a student has a private loan until it is disbursed, Mr. Draeger says.
Because there is little oversight of private lending and a simpler application process, some students borrow more than they need without realizing what they’re getting into.
Ms. Knowles, for example, said that she had not qualified for a federal student loan early in her college career, and that a family member had suggested she take out a private loan.
“I didn’t know a lot about all the financials—I just knew the tuition needed to be paid,” she says. “I don’t remember it being very complicated. I didn’t even have to get a co-signer.”
Bryan D. Reynolds, an emerging-media specialist with Gates Marketing, says his federal loans didn’t cover his entire tuition at Saint Leo University, in Florida, and his bank suggested he turn to private student loans.
“They asked me for almost no information,” Mr. Reynolds says. “They pretty much said, ‘Just sign this piece of paper and we’ll give you as much money as you want.’”
With the interest rate on federal loans about to double, legislators, college administrators, and federal agencies have been calling for ways to promote student-loan affordability and fair repayment options for borrowers.
U.S. Rep. Karen Bass, Democrat of California, introduced a bill on March 21 that would stop the interest rate from doubling and reduce student-loan debt by providing more-flexible options for repayment and permanently capping the interest rate on federal student loans.
Ms. Bass acknowledges that Republican majority is unlikely to support the bill, which includes a provision that would allow borrowers to convert their private student loans into federal direct loans if their student-loan debt exceeds their average adjusted gross income over the past three years.
Mark Kantrowitz, publisher of the student-aid Web sites FinAid and Fastweb, says refinancing should not be made as difficult for borrowers as it is.
Ideally, if borrowers repaid their debts on time, their credit scores would improve significantly a few years after they graduated, and their interest rates would drop if they refinanced, he says.
But only a half-dozen private lenders currently offer consolidating loans, and the opportunities to refinance private loans are limited, Mr. Kantrowitz says, in part because lenders lack the capital to make new loans in the wake of the recession.
Private lenders are also hesitant to refinance loans for struggling borrowers who are seeking to refinance their loans to solve their problems.
As Mr. Kantrowitz put it in a written statement to the Consumer Financial Protection Bureau, “The last thing any lender wants to do is ‘buy a default.’”
Minimizing Defaults
In February the consumer bureau asked for suggestions on how to make repaying private student loans more affordable and how to create a refinancing market.
Michelle Grindle of Chelmsford, Mass., is one of more than 500 people who have responded to the request. She says her student-loan debt, which she incurred while getting her bachelor’s and master’s degrees, has been “barely manageable” for the past six years.
“My biggest issues are not being able to consolidate my private loans at a reasonable fixed rate as well as pay any more than the interest,” she wrote.
On March 1, six Democratic senators—Dick Durbin of Illinois, Tom Harkin of Iowa, Al Franken of Minnesota, Jack Reed of Rhode Island, Elizabeth Warren of Massachusetts, and Sherrod Brown of Ohio—also sent a letter to 13 major banks, calling on them to work with regulators and student borrowers to reduce the number of those in default on their private loans.
“Oftentimes, flexible repayment options are only available after a borrower defaults and the loan is written off,” the letter states. “However, when a borrower defaults, no one benefits.”
Mr. Durbin introduced a bill in January that would allow privately issued student loans to be forgiven when a borrower files for bankruptcy. Current law does not allow federal or private loans to be forgiven in individual bankruptcy.
The consumer-protection bureau has also made strides toward increased regulation of the private-loan industry. Last month it proposed a rule that would allow it to more closely supervise large nonbank loan servicers to ensure that they follow the same consumer financial laws as banks. The rule is now in a 60-day public-comment period.
Although student debt will be a likely focus of discussion this spring as both the House and the Senate debate legislation to resolve issues with private lending, it is unclear whether either bill will pass.
On her current payment plan—which ends in 2024—Ms. Knowles will have paid nearly $48,000 for her original loan of $26,000.
“In an ideal world, you would go to college, graduate, get a job and make money, and make loan payments with nothing going wrong,” Ms. Knowles says. “But sometimes it doesn’t always work out that way.”