Two federal agencies cite problems with private student loans WASHINGTON - With more people steeped in student loan debt and defaults rising, two federal agencies are urging Congress to rein in private lenders that have flooded the market with often risky loans. The growth in loans from banks and other private lenders are exacerbating problems that college graduates - and dropouts - already have in repaying their government loans. Private loans made up about 15% of the $1 trillion in student loans outstanding last year. During the subprime housing boom in the mid-2000s, private lenders loosened their standards amid high demand from investors for loans packaged into securities, according to a report to be released Friday by the Consumer Financial Protection Bureau and the Education Department. The lax standards and aggressive marketing led some people to borrow more than necessary to pay for college, the report said. "Too many student loan borrowers are struggling to pay off private student loans that they did not understand and cannot afford," said Richard Cordray, director of the consumer bureau. We must do our best to leave the next generation in a better place than we are today, rather than buried under a mountain of debt. Although lending standards have improved since the financial crisis and private loans have fallen, changes still are needed to make the market work better, the report said. Among the recommendations are requiring colleges to certify that the money borrowed does not exceed a student's need and determine whether students have exhausted federal aid before a private loan can be made . The report found, for instance, that about 4 out of 10 private student loan recipients had not exhausted their federal loan limits. The agencies also said Congress should reconsider a law enacted in 2005 that made private student loans almost impossible to discharge in bankruptcy, unlike most other consumer debt. The report is the first detailed federal study of the private student loan market and comes as rising student debt has been called a ticking time bomb in an economy still struggling to recover from the housing market crash and the Great Recession. The Federal Reserve has estimated that as many as 1 out of 4 borrowers has an overdue student loan balance. Lawmakers scrambled last month to avert a doubling of interest rates on federal student loans, which would have added to the problem. Federal student loans offer more protection for borrowers than private ones, including reduced payments and even temporary reprieves for people having financial trouble, the report said. Those who fall as much as 270 days behind on their federal loan payments still have options to avoid default. In contrast, private student loans generally are placed in default when they are 120 days overdue. The report found that about 850,000 private student loans worth more than $8.1 billion were in default and that default rates for loans made from 2004 to 2008 continue to rise. Cordray did not directly recommend that Congress ease the bankruptcy rules governing student loans. But he strongly suggested such a move would be justified because the 131-page report showed no strong evidence that the improvements sought by the 2005 change - to lower prices and significantly increase access to credit - have taken place. For years, students turned to private loans as a supplement to federal aid. But their use increased dramatically starting in 2004, the report said. There were less than $5 billion in private student loans made in 2001. By 2008, the figure had ballooned to more than $20 billion, the report said. "Subprime-style lending went to college, and now students are paying the price," Education Secretary Arne Duncan said. From 2005 to 2007, private student lenders increasingly marketed loans directly to students instead of going through college or university financial aid offices. And the percentage of loans made without school involvement or certification of need rose to more than 70% from about 40%. Such aggressive lending led many students to borrow more than they needed to pay for college, the report said. In addition, private lenders were more likely to make loans to students with lower credit scores. "There are striking similarities between stories of the private student loan market and stories of mortgage market in the years leading up to the financial crisis," Cordray said. Just as with the mortgage market, lending has fallen off since the financial crisis and lending standards have improved, the report said. New private student loans fell to less than $6 billion last year. And private lenders have been taking fewer risks. The percentage of loans with a co-signer increased to more than 90% last year from 67% in 2008. And more than 90% of private student loans to undergraduates required the school to certify the student's financial need. But changes are still needed to improve the market for future borrowers, the report said. "We still have some work to do to ensure that students who take out private student loans have the same kinds of protections offered by federal loans," Duncan said. In the meantime, if you have to take out a loan to pay for college, federal student aid should be your first option.