What's Behind the Growing Student Loan Scandal

By Cameron Street – Exclusively for ERATE.com

The state of New York has taken the lead in investigating serious conflicts of interest which now appear to be widespread throughout the $85 billion student loan industry.  The investigation which began at the state level (rather than the federal one) now appears to involve officials at the U.S. Department of Education as it was reported last week that a senior official within the Department was a shareholder in the parent company of an organization making student loans.  Behind the investigation is the charge by some companies operating within the student loan industry, that unless they offer incentives and kickbacks (AKA bribes) to officers within the financial aid offices of colleges and universities, they are essentially locked out of getting on the campuses much coveted list of “preferred lenders”.  This list is normally generated by each campus and is relied upon by an estimated 90% of students seeking financial aid. Sadly now the question being raised is, were students being steered to these lenders on campuses’ “preferred list” because these lenders offered the best deals for their students or was it in fact because they offered the best financial incentives to the school and possibly its financial aid officers?

In the mid-90’s the feds attempted to cut private lenders out of the student loan process by letting students borrow directly from the Treasury, however private lenders have managed to hold onto about 20% of the total student loan market by offering discounts and better service.  Today the private student loan market is a highly consolidated one where it is estimated that only 32 lenders do up to 90% of the loan volume.  It has been revealed by the Department of Education that on some 300 campuses nationwide, there is one lender who may control an astounding 99% of all student loans.  Several lenders, Sallie Mae and Citibank, are projected to be the most dominant private players in the market, having originated some 22% of student loans in 2006.  Sallie Mae, which began as a federally guaranteed enterprise in the early 1970’s slowing began to privatize its operations and severed its government ties completely in 2004.   

The process of comparing private loans is a far more difficult task for students than comparing government-backed loans, because the rates and fees can vary significantly.  Government-backed loans have set maximums on their rates and fees (i.e. Stafford, Perkins, PLUS and Direct loans) so the terms of these loans have very minor variations between lenders. Most private loans are at variable rates of interest and tied to different indices.  In the mortgage industry, the annual percentage rate (APR) is the tool commonly used to make an apples-to-apples comparison of loans. Unfortunately there is no such common financial mechanism available to assist the student loan consumer in making comparisons while doing their shopping. 

To obtain a student loan, a college or university must certify a student’s qualifications.  Schools are not permitted to cause unreasonable delays when a student selects a lender outside of their list of “preferred lenders” however many campuses deter students from applying with lenders off their list by claiming increased loan application processing times for non-listed lenders.  But unless the chosen college or university participates directly in the government’s direct-lending program, a student should be able to select any private lender for a loan.  Private loans are typically more expensive than government guaranteed loans because of the increased risk to the investor absent the guarantee.   It’s alleged that colleges and universities have been offered substantial sums to switch from the government student loan program to that of private lenders whose profits in large part are based on government subsidies (that’s money provided by taxpayer’s like you and me).  And recognizing that a high percentage of students will select the first lender on a college or universities “preferred lender” list, many of these private lenders have negotiated revenue-sharing arrangements with the schools in order to make the grade or the list that is to say. 

Students and their parents can better protect themselves when shopping for a loan by comparing terms offered by those lenders on the campuses’ preferred list with offers outside or off the list as well.  Congress can do their part by cooperating with the New York investigation and by making it illegal for colleges and universities to accept anything of value from these private lenders.  A complete revamping of the system at the federal level may be required so that schools are no longer able to recommend preferred or favored lenders under these hidden, mutually lucrative arrangements.  The campuses need to convert the whole student loan process to an open, transparent one where students and parents can verify that any “preferred lender” is truly offering the best rates and overall terms to their student loan borrowers.   “Seven areas of concern” which were sited by the New York attorney general’s office in its case against Sallie Mae were as follows:

1. To ban the financial ties between lenders and campuses.
2. To ban the payments for preferred lender status.
3. To prohibit gifts and trips to campus officers by lenders.
4. To prohibit payments to campus officers in exchange for serving on a lender’s advisory boards.
5. To prohibit any lender call center employees from misrepresenting themselves as an employee of the college or university.
6. To require disclosure of a lenders full array of interest rates offered as well as their default rate.
7. To require disclosure of a lender’s agreement to re-sell their loans to another lender.

This list of concerns needs to be federally mandated, enforced and must apply to all lenders, colleges and universities nationwide.  Until this happens students could avoid the potential of any lender-campus impropriety by simply choosing to borrower their student loan money directly from the federal government or through campuses which have direct lending capabilities.