Private student lenders are stepping up their game to compete directly with government loans. For several years, private lenders offered mostly variable-rate loans that students used as gap funding to cover their needs above what they could get on government loans. Now private lenders are introducing loans fixed at nearly the same rates as some federal products, seeking to nab a bigger piece of the student loan market as outstanding debts balloon to more than $1 trillion.
The largest student lender, SLM (SLM), known as Sallie Mae, introduced fixed-rate loans earlier this month. On May 21, Discover Student Loans (DFS), the third-largest education lender, started a fixed-rate loan program as well. Wells Fargo (WFC), the second-biggest lender, had launched fixed-rate loans last summer. For families with good credit, the private loans could be as low as 5.75 percent—a full point lower than the 6.8 percent for unsubsidized federal loans.
To understand this change, a brief bit of history is in order. In 2010, President Obama signed into law reforms that reconfigured how students borrowed money for education. It eliminated a program that subsidized private lenders to offer fixed-rate loans that the government guaranteed in case students defaulted. That left private lenders with only variable-rate loans—great for students when interest rates are low but painful when rates shoot up. “It created a huge hole in our product portfolio,” says Steve Olszewski, a senior vice president at Discover Student Loans.
Enter the Federal Reserve, which has been keeping interest rates near zero to try to spur lending and revive the economy. Banks can borrow for almost nothing, so now they can lend at a fixed rate that’s similar to what the government offers. “Clearly the funding environment is very conducive to it,” Olszewski says.
Right now, the fixed-rate loans primarily compete against the 6.8 percent unsubsidized Stafford loans, which are largely for graduate students or families that don’t demonstrate financial need. The rate on subsidized Stafford loans is at 3.4 percent. Federal loans have other benefits too, such as debt-forgiveness for public service work. ”Overall, the unsubsidized Stafford loan still offers a better deal for all except the most creditworthy of borrowers,” writes Mark Kantrowitz, publisher of FastWeb (MWW), a site that helps match students with scholarships. With staggering default rates and so many factors to juggle, the Consumer Financial Protection Bureau is trying to make it easier for students to compare loan offers.
That may be more important if Congress doesn’t act by July 1, when the subsidized rate is scheduled to double, to 6.8 percent. Then the fixed-rate private loans might interest an even broader audience.