If you want to borrow a lot of money for college, you are not going to like what the mortgage mess is doing to you.
The credit crunch, which started with a panic over people missing home loan payments several months ago, has spread like a disease, infecting a broad range of loans. Now it may poison opportunities for college students to obtain some loans and is adding painfully high interest costs to many.
So far federal student loans, or the low-interest college loans offered under government rules, are still plentiful. Students who get Stafford loans pay 6.8 percent interest, which is relatively low compared with other loans available for college.
But concerns developed last week because some lenders have decided to stop giving out student loans. The lenders made the decision because they had trouble borrowing money themselves. And they need to borrow money in order to lend money to students.
The issues sprang from mortgage problems. Because homeowners have been missing payments, banks and other lenders have taken billions of dollars in losses. Lenders have become gun-shy, fearful that if they lend money, they won't be paid. They are also concerned because bond investors won't buy the packages of loan payments that are crucial in funding new loans.
These investors are aware that during the last few years, lending practices became sloppy. They aren't sure what loans to trust and what loans are suspect. As a result, the process of handing out money – whether to home buyers, college students or car buyers – has been paralyzed.
Until lenders and investors start feeling safe again, they are expected to hold on tightly to money.
That could mean that students who seek loans may have difficulty and might have to turn more to higher-interest private loans. And in this environment, families without good credit could be turned away or charged a lot, said Mark Kantrowitz, publisher of FinAid.org.
There is no way to know if the problem will subside quickly or last into summer, a time when incoming college students might be seeking loans. The credit-crisis problems have been worsening since last summer.
“Six weeks ago, I would never have said that colleges could run short” of student loan money, said Andrew Davis, executive director of the Illinois Student Assistance Commission. “Now I'm not so sure.”
In the past week, the state of Michigan said it was not going to be generating its usual student loans because it was having difficulty borrowing money. Some companies in the loan business have had similar problems.
For the moment, the federal government is trying to reassure students. A spokesman for the Department of Education said that if there is any slack in lending, it will step in by granting more loans at the 6.8 percent rate.
But it is also hinting at potential problems. Although the program could accommodate additional schools and the students and families they serve, the spokesman said, “The department is concerned the benefits of the (Federal Family Education Loan program) could diminish as a result of fewer lender participants.”
In other words, it's possible the government wouldn't be able to pick up all the slack if the credit crunch lasts long.
To appreciate this, you must understand that students receive federal Stafford loans in two ways. About 20 percent come from the government directly. The other 80 percent come from lenders who follow government rules, such as charging no more than 6.8 percent interest. But those lenders depend on borrowing money. The government doesn't have to borrow money from any source but the U.S. Treasury.
Davis said it would be a “bureaucratic nightmare” for the government to try to take on a 400 percent increase in loans.
He suggests that families immediately fill out their FAFSA forms, the financial aid forms students must complete, along with a tax return for their family, in order to qualify for a low-interest federal loan. That way a student may qualify early for aid instead of taking a chance on a shortage later. “Rest assured, if you are the last guy to ask for a loan, you might not get one,” Davis said.
He suggests staying on top of the process by following up with a student's college financial aid office.
Given the credit crunch, students are also likely to have problems with higher-cost private loans provided by banks and other lenders.
All loans are bogged down in this era of fear, so students are encountering tough lending standards and high interest rates.
The average rate for people who don't have the highest credit scores is about 12 percent, Kantrowitz said. Many are higher.
Although students should seek lower-interest federal loans before turning to higher-interest private loans, many will be burdened by the higher private loan costs, Kantrowitz said. Under federal rules, students in their first year of college can borrow only $3,500 in Stafford loans. Yet public universities often charge about $18,000 a year for housing, food, tuition and other fees. Private colleges can exceed $40,000 a year. Even in their junior and senior years, students can't borrow more than $5,500 with Stafford loans.
To make up for the difference, Kantrowitz says, parents can take out federal PLUS loans at an 8.5 percent interest rate. But he said they may run up against tougher lending standards. Although parents aren't turned away based on credit scores, if they have defaulted on other loans, they won't qualify.
Given the number of homeowners with mortgages they can't afford, Kantrowitz is expecting families to have difficulty accessing both PLUS loans and private loans. But he advises students: If a family is turned down for a PLUS loan, federal rules allow students to borrow more than the usual Stafford rules allow.
Gail MarksJarvis is a personal finance columnist for the Chicago Tribune and author of “Saving for Retirement Without Living Like a Pauper or Winning the Lottery.” Contact her at gmarksjarvis@tribune.com.
