Guest Post: Why We Need a Strong Consumer Financial Protection Agency

[Next week, the U.S. House of Representatives is planning to consider legislation that would overhaul the government’s financial regulatory system. As part of that bill, Congress would create a new federal agency that would aim to protect consumers from predatory lending practices. In this guest post, three student and consumer advocacy groups — Demos, the U.S. Public Interest Research Group, and the United States Student Association — explain why students should care about this legislation. The post is an abridged version of a paper the groups put out this week entitled “Subpriming Our Students: Why We Need a Strong Consumer Financial Protection Agency.” The groups’ views are their own and do not necessarily reflect those of the New America Foundation.]

By Heather McGhee, Rich Williams, and Angela Peoples

Now more than ever, our nation’s future depends on the educational and economic success of our young people. Yet with tuition skyrocketing and entry-level jobs flat-lining, students are borrowing more and more against their futures to pay for school. A startling 67 percent of the U.S. bachelor’s degree graduates last year had student debt, averaging about $23,200 per indebted student.

While most of that debt is in safe, lower-interest federal loans, a significant amount is in private loans that can carry interest rates of over 18 percent. In fact, due to aggressive marketing, nearly 3 million American students took out private loans last year, up from less than 1 million just four years before. Since federal loans are lower interest and have more borrower protections, taking out unnecessary private loans for college is like putting tuition on a high-interest credit card that students can’t pay off for years. And like credit cards, private loans carry costly penalties and fees and are marketed heavily to students regardless of need, resulting in unnecessary and damaging levels of expensive debt. Unfortunately, unlike with credit cards, there has been no “Credit Card Holder’s Bill of Rights” for student loans to reign in the worst abuses in the private loan market.

This absence of basic consumer protections is why American students need a new consumer watchdog.

The Consumer Federal Protection Agency

Americans overwhelmingly support enacting a strong Consumer Federal Protection Agency (CFPA) that can, like the FDA does for drugs and the Consumer Product Safety Commission does for toys and electronics, keep us safe from toxic financial products. A consumer agency would help curb the lending industry excesses responsible for the dramatic rise in high-interest debt and ultimately, for the financial meltdown and bailouts last fall. It would close the gap that currently leaves private lenders free to make abusive loans to students without supervision or limits. If Congress enacts a strong Consumer Financial Protection Agency, America’s students stand to benefit from more disclosure and fairer pricing.

Typical Abuses in the Private Loan Market

Aggressive marketing has resulted in America’s students taking out $120 billion in private loans over the past decade, but there is still no consumer watchdog to make sure they are treated fairly. There are virtually no rules protecting borrowers in the private loan market. Just about any company or school can offer a high-cost loan and market it to students as a “student loan,” at any terms it finds profitable. Typical private loan abuses include:

Unnecessary Loans. Any student with access to the full information should only buy a more expensive private loan after reaching the maximum federal loan amount first. However, full information is increasingly the exception, and not the rule. Last year, almost 2 out of every 3 private loan borrowers did not reach the Stafford limit before taking out a costlier private loan; 26 percent took out no Stafford loans at all. As with other high-cost financial products, from subprime mortgages to payday loans, racial disparities suggest predatory targeting: African Americans are disproportionately likely to use private loans.

Outrageous Rates. Unlike federal loans, most private loans have no upper limit on their interest rates. As a result, private student lenders charge annual percentage rates (APR) as high as 18 percent—nearly three times the average federal loan APR and twice as high as the federal cap on student loans.

Rate Floors, Not Ceilings. During the recession, the federal government has lowered interest rates to make money cheaper for lenders—but the savings have not flowed through to millions of private loan borrowers. That’s because instead of ceilings, many private loans have rate “floors” guaranteeing that the borrower’s interest rate stays high. The resulting spread that lenders are pocketing is as high as 12.5 percent.

High Fees. There are no legal limits on the fees private lenders can charge students. 

In-School Interest. With federally-subsidized loans, the government pays the interest while the student is in school and not making payments. Private lenders start running the clock from the moment of origination. The difference is significant: a college freshman who takes out a private loan for $1,500 at the start of the year will owe $2,945 on that loan alone the day she graduates. Taking out the same private loan for each year of study will leave her with a bill upon graduation of $9,223—for just $6,000 in loans.

Aggressive Marketing at For-Profit Schools. While only 9 percent of undergraduates attend for-profit schools, these students make up 27 percent of private loan borrowers. As aggressive marketing has driven record growth in private loans, the biggest rise has been among for-profit schools. Nearly half of all for-profit school students had private loans last year, up from just 12 percent four years earlier.

It should be our shared responsibility to help America’s youth build a strong foundation for our future. If we let profit-seeking companies target our students with “easy credit” that they’ll be struggling to pay off for years, our economy will suffer in the long-run. A Consumer Financial Protection Agency — with no loopholes for private loans or for-profit schools — will help us guarantee all students an affordable education.

Heather McGhee is the Washington director of Demos, a nonpartisan public policy research and advocacy organization. Rich Williams is the Higher Education Assocation for the United States Public Interest Research Group, a consumer advocacy organization. Angela Peoples is the legislative director at the United States Student Association, the country’s oldest and largest national student-led organization.