Americans have racked up $150 billion in private student loan debt, with many graduates owing more than they can afford, according to a new report from the Consumer Financial Protection Bureau.
While these loans represent a small slice of the total outstanding student loan debt in the country -- which topped $1 trillion in 2011 -- they have caused big financial problems for borrowers, the CFPB and the Department of Education found after analyzing data from nine of the biggest private student lenders on roughly 5 million loans.
Private student loans were aggressively marketed to students before the financial crisis and typically came with fewer protections and higher interest rates than federal loans, the report found.
"Too many student loan borrowers were given loans they could not afford and sometimes for more money than they needed," CFPB director Richard Cordray said on a call with reporters. "They are now overwhelmed by debt and regret the decisions they made."
Defaulted private loans currently total more than $8.1 billion, representing 850,000 individual loans, according to the report.
Before the financial crisis, private lenders "engaged in aggressive marketing and risky underwriting," often borrowers didn't have good enough credit to qualify for the loan, said Cordray.
When the financial crisis hit, lenders began tightening their lending standards. Now, they are doing a better job of lending more appropriate amounts of money to students, working more closely with schools to determine a borrower's needs and asking for co-signers.
"After the financial markets crashed, some common-sense practices returned," Cordray said. "Without investors willing to buy risky loans, lenders were forced to care more about a borrower's ability to repay."
But that doesn't help the students who took out loans before 2008. And while federal loans come with certain protections if a borrower is having trouble repaying the loan, private loans don't have most of the same protections -- like flexible repayment options, as well as forbearance, deferment and forgiveness options, the report said.
Private student loans used to be dischargeable in bankruptcy like any other consumer debt, but under a 2005 change to the bankruptcy code, private student loans can no longer be discharged unless borrowers can prove undue hardship -- the same rule that applies for discharging federal student loans.
And while federal interest rates are fixed, private loans typically carry varying -- and often higher -- interest rates based on credit worthiness. Even when some private lenders advertise interest rates that are competitive to federal loans, the CFPB said they are often only available for borrowers with excellent credit or who have co-signers with excellent credit.
To prevent students from taking out private loans they can't afford and to help those who are already struggling to pay back private loans, Cordray made five recommendations to Congress in the report.
First, he said Congress should consider requiring private lenders to coordinate with schools before they are able to extend a loan to a student, and he said the lenders should get the loan amount approved with the school to make sure the student isn't taking out a larger loan than they need.
Cordray also recommended that Congress determine whether the bankruptcy code should be modified to allow private loans to be discharged. While the 2005 changes to the bankruptcy code, which stopped consumers from discharging private student loan debt, aimed to bring down private loan prices and increase access to credit, the CFPB said it found no evidence that this has happened.
Other recommendations included clarifying the definition of a private student loan to prevent confusion among borrowers and finding a way to clarify overall debt obligations for private loans. He said students also need to receive more information about what kind of post-graduation outcome they can expect before enrolling in a certain school -- like what kind of employment options and salaries may be available upon graduation.
"For many of these people, the decision about how to pay for college was their first major financial decision," said Cordray. "Without clear guidance or a good way to compare the pros and cons of different loan options, many students got in over their heads in debt."