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Students with private debt left out by Obama plan

Gan Golan of Los Angeles holds a ball and chain representing his college loan debt during Occupy DC activities in Washington.Jacquelyn Martin / AP

The Obama administration’s plan to ease the growing financial burden on college students has been welcomed by education analysts. But they also point out one major flaw: The program does nothing about the problem of costly private student loans, many of them handed out to hard-pressed students at for-profit colleges.

The White House move, announced this week, caps the maximum required payment on student loans at 10 percent of annual discretionary income rather than 15 percent and makes other changes so students can consolidate payments and have more debt forgiven.

About 7.4 million borrowers could be affected.

But the changes affect only the government portion of the growing student debt problem and not the booming private sector.

Collectively, Americans owe a staggering $1 trillion in student-loan debt. This total climbed during the recession even as other consumer debt shrank.

And student debt is likely to increase further: Tuition at public colleges rose 8.3 percent this year, more than double the rate of inflation, while priavte-college tuition rose 4.5 percent, according to the College Board.

College lending is a byzantine marketplace of direct government loans and loans privately offered by banks or other lending entities. Until last year, entities like Sallie Mae and some banks acted as middlemen for some government loans as well.

Terms are regulated under a patchwork system that includes the FDIC and state agencies, leaving students vulnerable to predatory and abusive practices, said Deanne Loonin, director of the Student Loan Borrower Assistance Project at the National Consumer Law Center.

Advocates say the problems are especially acute for students who borrowed privately.

Private loans are “one of the riskiest ways to pay for college," says Lauren Asher, president of The Institute for College Access and Success. "If you have private student loan debt you're really at the mercy of your lender."

Private lenders have become more important over the past decade in conjunction with the rise in for-profit colleges.

From 1998 to 2008 enrollment at for-profit institutions grew by 225 percent, compared with 31 percent across all post-secondary institutions. Behind this meteoric growth was an effort by these schools to target lower-income people who traditionally didn't have the means to attend college and, as a result, relied more heavily on loans to fund their education.

By law, for-profit colleges can earn up to 90 percent of their revenue from government aid; the other 10 percent has to come from other sources. In a student population with little savings or accumulated wealth, this translates to private loans.

Prior to the 2008 credit crash, banks served the subprime student loan market in much the same way they served the subprime mortgage market, and advocates like Loonin say many of the same abuses took place.

Colleges pushed students into private loans without taking into account their need or ability to repay. According to the Project on Student Debt, more than half of private-loan borrowers would have been eligible for more federal loan aid. But the schools needed the 10 percent in private revenue on their books, which motivated them to push expensive, risky loans on students.

"It's not that they really care about these loans," Loonin says. "They're doing it largely because they want to make sure they can keep the federal gravy train."

Private loans almost always cost more than government loans, and lenders don't extend the grace periods, deferments and other accommodations that are built into the federally backed loans. Private-loan borrowers in four-year degree programs at for-profit colleges are more likely to drop out before graduating than their counterparts at nonprofit schools. That leaves them with both accumulated debt and no degree that could help them land a job with sufficient income to make monthly payments.

A study conducted by the Institute for Higher Education Policy found that more than half of borrowers in for-profit, four-year programs were either delinquent or in default on their student loan payments.

Student advocates like NYU Professor Andrew Ross have recently joined with Occupy Wall Street protesters to call for lender forgiveness of student loans. It's a radical idea unlikely to gain traction even among policymakers generally sympathetic to the plight of indebted grads, but Loonin says there are steps the government could take to provide some relief.

Unlike most other unsecured consumer debts, student loans can't be discharged in bankruptcy. Federal student loans can't be discharged either, but the consequences are greater for private-loan borrowers, since interest rates, penalty and late fees assessed by lenders aren't limited or capped.

Related: Protesters urge making student debt disappear

Loonin and other advocates say students' best chance at protection from predatory lenders will come from the new Consumer Financial Protection Bureau. The CFPB's interim leader, Raj Date, this week unveiled an online guide for students and parents along with a template for colleges to standardize their financial aid information to make it easier for students to assess their aid options.

But Mark Kantrowitz, publisher of FinAid.org and FastWeb.com, warns that coming changes to federal student loan programs designed to close some of the loopholes for-profit colleges exploit could have an unintended consequence: A growing number of these institutions are beginning to offer loans directly to students, then maximizing their revenue by bundling those loans into securities and selling them to investors.

It's a complicated system, but the main impact for borrowers is that it will be harder for them to obtain relief from their lender if they face financial hardship.

"You really can’t modify the terms of loans once they're securitized," he says. For for-profit colleges, the appeal is obvious. "They can sell them to investors, so that's an immediate payment," Kantrowitz says. But once again, this easy money for lenders comes at the expense of students' financial stability.

Related:

Obama unveils plan for student loan relief

US opens new front in fight with for-profit colleges