Misperceptions of Educational Lending
U.S. student loans now total more than $1.4 trillion from over 44 million borrowers.
In 2010, the government overhauled the federal student loan program to eliminate Federal Family Education Loan (FFEL) program, government-guaranteed student loans provided by banks and non-profit lenders. The Congressional Budget Office forecasted taxpayers would save $68 billion over ten years by removing private lenders from the federal student loan program. Over the past five years, the government student loan portfolio has grown at a steady rate while severely delinquent loans have skyrocketed. Recent forecasts project an over $300 billion cost to taxpayers over the next ten years, as many of those loans will never be recovered.
Today, the average student loan balance exceeds $37,000.
Many students, upon graduation, are burdened with high student loan repayments they cannot afford to pay back. The number of Americans who have defaulted on student loan repayments is at an all-time high and continues to rise rapidly. Even more alarming is more than half of delinquent borrowers never graduated.
Approximately ten percent of the $1.4 trillion federal student loan debt is more than 30 days past due. In addition, another 20% is in deferment or forbearance and about 30% is in income-based repayment plans that allow most borrowers to cap monthly payments.
Those not in default have been able to afford the high monthly payments at the expense of other lifestyle purchases, such as rent, a new car, a first house, home improvements, or a retirement plan. Some experts estimate that 300,000 more homes would be sold annually if Americans were not saddled with student debt, boosting the housing market and economy. A recent Moody’s report adds, “…U.S. real GDP could be boosted on average by $86 billion to $108 billion per year.”
Student loan debt peaks at age 34.
Recent graduates are not the only borrowers feeling the impact. The Department of Education reports there were 17% more student loan borrowers age 62 and older in 2019 than in 2018, the largest increase among all age groups. Many parents are taking personal loans and home equity lines of credit to help their children pay for the cost of higher education, further impacting the student loan debt impact on the economy.
Demand for higher education continues to grow.
Tuition and fees continue to escalate as demand exceeds the rise in income. Higher education costs have soared more than 530% since 1985, while the consumer price index has only risen by 121%. The average tuition and fees for a public four-year out-of-state college is $26,290 and for a private nonprofit four-year college is $35,830.
Now for the good news…private student loans perform well.
It is important to understand the differences between federal student loans and private student loans. Approximately 90% of student debt is issued by the federal government, whereas about 10% of student debt is issued by private student loan lenders such as banks, credit unions, and state agencies. The underwriting requirements for these two types of loans are dramatically different. That is, federal loans generally do not require a credit check. In contrast, private student loans require a more stringent credit review to determine the borrower’s ability to repay the loan. Accordingly, private student loan portfolios perform well compared to federal loans. In fact, approximately 98% of families are successfully managing payments and less than 2% default, annually.
Market Leaders and New Entrants
Fintechs and new market entrants have recognized the market opportunity in private student loans.
Private student loans account for over $10 billion of the $1.4 trillion market. Historically, 85% of the private student loan market has been dominated by four key players: Sallie Mae, Discover Financial Services, Wells Fargo, and Citizens Financial Group. The market leaders are strongly entrenched as in-school student lending requires enterprise-wide commitment to all channels – digital, direct mail, partnerships, and an on-the-ground sales force to get on school lender lists and proactively market student loans on-campus.
But expect to see new players challenge the established players. For example, long-time student loan servicers – such as Navient, NelNet, and Pennsylvania Higher Education Assistance Agency (PHEAA) – have aggressively pursued student loan origination products. Regional banks, credit unions, state agencies and Fintechs – such as Sofi – will also aggressively pursue the education finance market as they recognize the profitability and strong performance of private student loans.
Next Generation Customers
Many traditional large banks continue to have concerns about student lending. For some, a stigma remains for those who remember the large banks exiting the student lending business when the U.S. Department of Education took over federal loan programs in 2007.
Banks also cite concerns about politicians threatening to change laws to forgive student loan defaults. As the 2020 election approaches, Democratic Senators Elizabeth Warren (MA) and Bernie Sanders (VT) have proposed sweeping plans to cancel hundreds of billions of dollars in existing student debt. Senator Warren proposes a 2% tax on families with more than $50 million in wealth. Whereas, Senator Sanders proposes a tax on financial transactions to pay for his plan. However, the general consensus is these proposals are very costly. If private student debt were canceled by the U.S. government, it would adversely impact pricing and available of private student loans in the future. Therefore, it is unlikely to become law in their current form.
But other financial institutions view private student loans and education refinancing products as “stepping stones” to other products and establishing trust with the next generation of digital customers. Helping younger customers with their education finance needs positions them well to sell future products such as auto, home, wealth management, and retirement.
It is an interesting time in the education finance market. The established players are being challenged by new entrants and those well-positioned will have a distinct competitive advantage in the future.