With all the generally negative media news this year about student lenders pulling out of the market, we are often asked how credit unions are addressing the key areas of risk in private student lending. Below are seven of the primary ways that credit unions are mitigating the key areas of risk to effectively engage in this new loan segment:
1) The government already reduces a primary risk
–Student loans are one of the few consumer loan segments where the borrower cannot be absolved of obligation by declaring bankruptcy. This law is important as it enables the student loan markets to exist. After all, there are not many lenders who would be willing to make a $20,000 unsecured loan if the twenty year old borrower could declare bankruptcy after graduation.
2) Participate only in school certified loans
- Certified student loans involve the school in the loan approval and funding process. The school validates the enrollment of the student, their financial need, and required funding dates. Loans are disbursed directly to the school (not to the student) to ensure the money is used for the intended purpose. Any excess funds are disbursed by the school to the student.
3) Require a Co-Borrower
- Most student loan experts agree that established credit scores (like FICO) are often still the primary driver in determining the propensity to repay the loan obligation. Since students most often will have very thin credit histories (if any) that score alone can be misleading if used for underwriting. Requiring a co-borrower that meets minimal eligibility requirements helps make these scores more meaningful.
4) Consider the schools you will lend to carefully
- The federal government publishes every school's "cohort default rate" for the federal student loan program. This is the percentage of a school's federal student loans in default and can be used by lenders as an indicator for the risk in non-federal student loan programs. Traditional four-year and not-for-profit schools generally have a lower cohort default rate than for-profit, trade, or community colleges.
5) Private loans have a variable interest rate
- LIBOR and PRIME are commonly used by lenders (plus or minus a spread based on the applicant). This significantly reduces the credit union's interest rate exposure.
6) Risk-based lending (FICO and School)
– The value of risk-based pricing should require no explanation for credit unions. The co-borrowers FICO and the school the student is attending are criteria that are used by credit unions in pricing these loans.
7) Consider Loan Portfolio Insurance Options
- Despite the general troubles in the insurance industry, there are still insurance options available for student loans. Policies are still being written and firms remain committed to private student loans in the future. Some credit unions choose to self-reserve for losses while others prefer the comfort of entering the new market more conservatively with the insurance coverage.