The Market for Student Loans

Federal Loans

As tuition and living expenses continue to rise without a corresponding increase in federal and state aid, more and more students and their parents have turned to student loans to satisfy this unmet need. More than 65% of undergraduate students and 75% of graduate and professional students take on educational debt. Most students borrow through one of two Stafford loan programs sponsored by the federal government. Under the Direct Loan program, the government disburses federal funds directly to school financial aid offices. Under the Family Federal Education Loan (FFEL) program, eligible lending institutions (like Meritas) disburse funds on behalf the government. Whether a student receives Direct or FFEL Stafford loans is at the discretion of his/her financial aid office, but both sources offer relatively similar borrower terms and conditions. The Perkins loan program, which represents less than 5% of student aid, is administered on a school-by-school basis and provides loans to students with demonstrated need.

All Stafford loans have a variable rate that is reset on July 1st of each year while Perkins loans carry a fixed rate of 5%. All Federal loans are either subsidized or unsubsidized. Perkins loans and subsidized Stafford loans carry government subsidies that provide for the interest payments while a borrower is still in school. Therefore, a borrower who takes out a subsidized Stafford loan for $3,000 will owe $3,000 when the loan enters repayment. Unsubsidized Stafford loans, however, begin accruing interest upon disbursement. Although a student does not need to make interest payments on this loan while in school, the interest does accumulate. If the interest is not paid off before the loan enters repayment, all accrued interest capitalizes or gets added to the principal balance. A student has up to 10 years to repay his/her Stafford or Perkins loans.

A relatively new, but important, development in the federal student loan market has been the consolidation loan program. A consolidation loan offers three major benefits to student borrowers. First, it allows borrowers to stretch their repayment period up to 30 years (depending on the borrowers total educational debt balance). Stretching the repayment period lowers the student's monthly payment which can help free up cash flow for other expenses. Second it allows the borrower to fix or lock-in the prevailing Stafford loan rate. This assures that the student's payment amount will not change over the life of the loan. Finally, a consolidation loan bundles all of a students federal loans into one new loan, easing the administrative burden of managing multiple statements and payments.

Private Loans

Rising tuition and living expenses have also contributed to the development and rapid growth of the private loan market. The Higher Education Act (HEA), which regulates federal financial aid policy, including annual and aggregate loan limits, is reauthorized every five years. Reauthorization of the HEA is currently underway and while many have called for higher loan limits, economic circumstances and budget deficits are unlikely to permit substantial increases.

Private loans are used to bridge the gap between federal loan limits and the cost of attendance (COA). While the COA typically increases 5-10% annually, federal loan limits have remained stagnant for over a decade. The result is a fast-growing gap that must be financed by, savings, scholarships or private loans. Private loans differ markedly from Federal loans in that they are not subsidized and typically require a credit inquiry to determine eligibility. Private loans carry a variable rate that is often tied to a market index (Prime Rate, LIBOR). A margin is added to the index rate to adjust for the risk associated with lending to individual borrowers. This rate is often reset quarterly and borrower payments increase or decrease accordingly. Terms, conditions and fees vary widely on private loans and borrowers should research their options carefully.

Given the recent attention being paid to the federal consolidation program, many students have inquired about private consolidation loans. While a private consolidation loan doesn't currently allow students to fix the rate, it does provide a longer payment horizon, lower monthly payments and simplified billing. It will also improve a borrower's debt-to-income ratio which can allow for easier access to and better terms for additional consumer credit (mortgages, home equity etc.) Meritas is excited to offer the first private loan consolidation loan with both affordable rates and a guaranteed 30 year term.