Private education loans: History and issues
FINANCIAL INSTITUTIONS INSIGHTS |
Student loans represent a significant subset of overall consumer lending. Traditionally, student loans are either federal or private, with the distinction indicating the existence of any government subsidy and/or guarantee. Until July, 2010, student loan originators – both bank and non-bank – were able to originate both federal (FFEL) loans and their own private loans. The FFEL Program was eliminated under the Health Care and Education Reconciliation Act of 2010. Now all federal loans are originated directly by the government, though traditional originators still have the opportunity to win servicing contracts.
Along with participation in the FFEL Program, many student loan providers offer private student loans, which are pure consumer loans designed by the lenders and made with their own funds. Many private loans programs share common attributes with federal loans, most notably a period of deferment. As with federal loans, private student loans are presently very difficult to discharge in bankruptcy, although there have been numerous legislative attempts to change this.
Whereas federal loans are explicitly exempted from many consumer protection regulations, private education loans are subject to the complete range of applicable law and regulation, including:
- The Truth in Lending Act (TILA)
- The Electronic Funds Transfer Act (EFTA)
- The Fair Credit Reporting Act (FCRA)
- The Equal Credit Opportunity Act (ECOA)
- The Gramm-Leach-Bliley Act (GLBA)
While private education loans made by banks are subject to regulatory scrutiny during the banks regular examination cycle, non-bank loan programs have typically not been subject to comprehensive or cohesive examination. Instead, these programs have been subject to a variety of state-based licensers and regulators, with potential enforcement action from the FTC and state Attorneys General. The last five to ten years have been a period of intense political scrutiny for private education loans. Many providers have found themselves under the microscope of individual politicians and legislative bodies.
The Dodd-Frank Act gave the Consumer Financial Protection Bureau (CFPB) express authorization to examine and regulate non-bank providers of private education loans. Thus, the CFPB will be the first regulatory authority focused on most non-bank loan programs. The CFPB has prepared examination procedures and has begun examining non-bank private lenders. These procedures, along with a heightened level of scrutiny for private education loans likely will soon be applied by the traditional prudential regulators.
Key risk factors for private student loans, and areas requiring mitigation, include the following:
Marketing and advertising
In the past, some private lenders have marketed their products in ways that confused private loans with federal loans. Additionally, instances have occurred where school representatives were encouraged to promote one lender's product over another, without regard to which product best met the needs of students. Controls should include compliance involvement in marketing and proper relations with schools
Application and origination
Private lenders face compliance risk involving the origination of private loans, predominantly with regard to the specific private loan disclosure requirements of Regulation Z. Subpart F of regulation Z includes special rules for private loans, including the provision of certain disclosures to the consumer at three distinct times in the application and approval process. Additionally, this part allows for a cancellation period after approval, during which the lender may not fund the loan. Since private education loans are generally a high-volume business for lenders, appropriate controls must ensure that automated systems work properly to provide timely and complete disclosures and to ensure that funds are not disbursed prior to the mandated cancellation period.
Fair lending and risk-based lending
Many student loan products are available based on the risk a consumer presents. Lenders face risk in the possibility that lending practices may unfairly disadvantage a protected class of consumer. In addition, certain disclosures are required relative to risk-based pricing practices. Proper controls should include testing designed to reveal whether any judgmental or automated underwriting systems allow for discrimination or disparate treatment of certain consumers. Moreover, controls should ensure that proxies for protected classes are not used by lenders to price loans.
Servicing and collections
For many reasons, student loans are complicated. It is not uncommon for consumers to misunderstand the debts they have incurred. Student loan servicing systems must be designed to promote clarity and transparency. Necessary controls include validating the manner in which information is provided to consumers and the quality of that information, including information regarding repayment status and payment options.
Risk is present when lenders are not aware of how their products and services are perceived by consumers. The way to gauge this perception and to mitigate risk is to understand complaints. Private education lenders must have controls in place to log, respond to and analyze complaints.
Although the compliance risks for private education lenders are not entirely new, they have never been greater. The CFPB brings a level of scrutiny to the industry that it has rarely, if ever, seen. Lenders must ensure that they understand their compliance responsibility and that compliance management systems are without gaps.
For further information on this subject, contact Ryan Charlton, Supervisor, McGladrey LLP.