College students across the nation may soon face the residual effects of a crashing subprime lending market, which saw default and foreclosure rates skyrocket this summer.
But while the loan crisis has the potential to produce a detrimental effect on many loans to students, Jumbos will likely avoid the worst of it.
Subprime loans are loans given to borrowers who, because of their credit history, do not qualify for the best interest rates the market offers. These often include loans to college students.
The recent lending crisis, which was centered in the mortgage industry, has left several subprime lenders bankrupt and has caused the foreclosure of several million mortgages. According to a recent study by the Center for Responsible Lending, a non-profit organization, nearly one in every five subprime mortgages issued in 2005 and 2006 is expected to fail.
This recent foreclosure spike has sent tremors through financial markets.
During the real estate boom of the early 2000's, lenders made many subprime loans, the most common form of which were adjustable rate mortgages with low initial interest rates. However, interest rates on these loans typically rise sharply after the first few years.
Since subprime loans are typically issued to buyers with less-than-perfect credit histories or low credit scores, they run a high risk of default once the interest rates start to climb.
The high foreclosure and loan default rates have hurt lenders' pockets and scared off investors who would otherwise have provided the capital lenders need to make their loans. As a result, lenders have had less capital with which to make more profitable loans and have lost more and more revenue. This has scared investors further, provoking a vicious downward spiral.
Executive Director of America's Student Loan Providers (ASLP) Kevin Bruns said that many markets have been affected. ASLP is a lending coalition that includes loan giant Sallie Mae and several other subprime lenders.
"Investors have been spooked," he said. "Investor confidence is low. The crisis has affected the entire asset-backed securities market."
Unfortunately for students, the asset-backed securities market includes student loans, which come from the lenders most affected by the crisis.
Such lenders make the majority of their profit-providing loans under the Federal Family Education Loan Program, which are heavily subsidized by the federal government.
However, some legislators have long complained that subsidies to student loan providers were far too generous, and that such providers were profiting excessively from government generosity.
In March 2007, President George W. Bush proposed a budget that cut lender subsidies significantly. In September, he signed the College Cost Reduction and Access Act, which reduced subsidies even further.
Bruns said he believes the current market difficulties will be reflected in the availability and cost of some student loans.
"The cost of making loans has gone up," he said. "Sallie Mae is going to look more closely at who it makes loans to, and other lenders will do the same. Some may not offer student loans at all."
Sallie Mae's difficulties translated into student loan problems when the lending company wrote in a filing with the Securities and Exchange Commission in early January that it plans to be more selective in granting loans.
FinAid, a student guide to financial aid, speculated that the minimum credit score needed to secure a loan would jump from 620 to 650 and that student loan interest rates would likely rise one percent across the board.
Other possible changes include increases to minimum balance requirements for loan consolidation and cuts to origination fee waivers and consolidation discounts.
According to Burns, students with low credit scores may also have trouble getting loan co-signers. All of these changes mean that private student loans will be more expensive and harder for students to obtain.
What is beneficial for Jumbos is that federal student loans, which include Perkins and Stafford loans and comprise all of the loans included in Tufts financial aid packages, will remain more insulated from the fluctuations of the lending market.
Though the banks making these Perkins and Stafford loans get their capital from the private loan market, the loans are guaranteed by the federal government.
"This is a 95 to 97 percent guarantee," Bruns said. "So lenders are willing to make [the loans] more cheaply."
Patricia Reilly, co-manager of Tufts Student Financial Services and director of financial aid, was confident that Tufts students would not feel the pinch. Tufts loans "will not be affected by the subprime lending crisis," she said in an e-mail.
"We do not anticipate making any changes to financial aid packages, and Tufts students will not see any changes in the terms of their student loans."
One way of eliminating the potential problem comes in the form of loan replacements.
Tufts joined many schools when it recently announced a plan to replace student loans with grants for low-income students.
Bruns said that Jumbos have little to worry about in the near future regarding securing private loans in addition to their university financial aid packages.
"Tufts is a good school with a high graduation rate," he said. "Lenders are most worried about school with low graduation rates. This only affects the bottom 20 to 25 percent of colleges."
