Congress on the Verge of Making Private Loans Safer for Students

Congress is expected to approve landmark legislation this week that would, for the first time, put a single federal agency in charge of regulating private student loans, rather than the patchwork of agencies that have done little to curb the types of predatory private loan practices we have written so much about.

Although the final version of the financial regulatory overhaul bill does not go quite as far as we would have liked, it appears that it would go a long way towards making private loans safer for students.

The following are some of the most promising aspects of the legislation. The bill would:

• Create a federal watchdog agency with the type of broad authority needed to rein in abuses:

The new Consumer Financial Protection Bureau (CFPB) would be in charge of writing rules that apply to all private student loans, including those offered by non-banks, such as Sallie Mae and for-profit colleges. The bureau would have the authority to set standards related to the underwriting and marketing of private loans and to determine the types of disclosures lenders would be required to make to prospective borrowers.  The bureau would not, however, be able to dictate loan terms. The legislation expressly bars lenders from capping the interest rates that they can charge borrowers.

The CFPB would also have full oversight and enforcement authority over non-banks and banks with more than $10 billion in deposits. Private loan providers that fall under this exemption would still be required to abide by the bureau’s regulations -– it’s just that enforcement of these rules would be left to their current regulators. For example, the Federal Deposit Insurance Corporation (FDIC) would be responsible for ensuring that private loans Sallie Mae finances through its bank in Utah (appropriately known as the “Sallie Mae Bank”) comply with the bureau’s rules. Presumably, the bureau could also take enforcement actions against Sallie Mae itself because it is not a bank.

Significantly, the final bill includes a provision that was in the House of Representatives version that would give the CFPB regulatory, oversight, and enforcement authority over the sub-prime private loans that for-profit colleges make directly to their students. This is important because some schools are making these high-risk loans even though they know full well that many of the low-income and working-class students who take them out won’t be able to repay them. Corinthian Colleges, for example, has told investors that it expects nearly 60 percent of the $150 million in “institutional loans” it is making to students this year to end up in default. For the schools, these losses are more than offset by the federal financial aid dollars these students bring in. But for the students, defaulting on these loans could lead to a spiral of debt that could literally ruin their lives.

• Introduce a Private Student Loan Ombudsman

If the bill is enacted, private loan borrowers will, for the first time, have somewhere to turn when they get into disputes with their lenders. The legislation would create a new Private Student Loan Ombudsman within the CFPB who would be in charge of assisting borrowers who run into problems with their private loans. This official would work closely with the Federal Student Loan Ombudsman at the U.S. Department of Education to help resolve disputes that arise with borrowers who have both government-backed and private loans. Currently, the Education Department’s ombudsman can only help such borrowers with their federal loans.

Even more significantly, the private loan ombudsman would be responsible for analyzing complaints that borrowers file with the bureau against their lenders to determine whether there are any clear patterns of abuse occurring — and to make policy recommendations to Congress and the Administration to address them. These proposals would be included in a report that the ombudsman is required to submit to lawmakers and the Secretaries of Education and the Treasury each year.

For far too long, federal officials have turned a blind eye to the types of predatory practices that have been prevalent in the private loan industry. With the introduction of the ombudsman, they no longer will find it so easy to do so.

• Potentially Ban Mandatory Arbitration Clauses in Private Loan Contracts

The legislation would give the CFPB the authority to eventually ban the use of binding arbitration agreements in consumer financial contracts (pending the completion of  a study on the subject) if the agency determines that doing so “is in the public interest and for the protection of consumers.” At Higher Ed Watch, we have shown how one major lender — KeyBank — has used these types of agreements to try to prevent students who have been scammed by fly-by-night trade schools from being able to challenge their private loan contracts in court. According to the National Consumer Law’s Student Loan Borrower Assistance Project, this is hardly an isolated case. The group says that these clauses are typically hidden in the fine print of students’ promissory notes. As a result, by signing their loan documents, students often unwittingly forfeit their right to take lenders to court.

We certainly believe that this is an abusive practice that needs to be stopped. We would hope that the bureau would act at the earliest date possible to ensure that borrowers’ legal rights are protected.

What’s Missing

As we said earlier, the bill is not without disappointments. We particularly remain perplexed as to why Sen. Chris Dodd, the Connecticut Democrat in charge of the Senate Banking Committee, was so adamant in refusing to include in the final bill a provision that would have required colleges to certify a student’s need for private loans before that individual could receive them. The proposal, which had been part of the House version of the legislation, aimed at giving college financial aid administrators the opportunity to counsel students about their federal financial aid options so that these students do not take on unnecessary private loan debt.

Dodd’s opposition to the provision is all the more confounding considering that it had broad support among an unusual coalition of groups, including those representing students, financial aid administrators, and student loan industry lobbyists.

Consumer advocacy groups are holding out hope that the consumer protection bureau could eventually act on its own to require private loan certification from schools. We hope they are right — because we can think of no better way to help ensure that students exhaust their eligibility for federal loans before taking out higher-cost and more-risky private loans.

We would also hope that the bureau would help lead an effort to get Congress to reverse a federal law that makes it exceedingly difficult for financially distressed borrowers to discharge private student loans in bankruptcy. As we’ve said before, private loans should not be treated any more harshly in bankruptcy law than other forms of consumer debt, such as credit cards.

Conclusion

All in all, this legislation represents a major step forward in bringing order to what has long been a virtually unregulated private student loan marketplace. We join our colleagues at the Project on Student Debt in urging Congress “to pass this legislation and finally rein in the ‘wild west’ of student lending.”