A new report issued in January by the National Consumer Law Center accuses for-profit colleges of saddling their students with unregulated private-label student loans that force these students into high interest rates, excessive debt, and predatory lending terms that make it difficult for these students to succeed.

The report, entitled “Piling It On: The Growth of Proprietary School Loans and the Consequences for Students,” discusses the boom over the past three years in private student loan programs offered directly by schools rather than by third-party lenders. These institutional loans are offered by so-called “proprietary schools” — for-profit colleges, career schools, and vocational training programs.

Federal vs. Private Education Loans

Most loans for students will be one of two types: government-funded federal student loans, guaranteed and overseen by the U.S. Department of Education; or non-federal private student loans, issued by banks, credit unions, and other private-sector lenders. (Some students may also be able to take advantage of state-funded college loans available in some states for resident students.)

Private student loans, unlike federal undergraduate loans, are credit-based loans, requiring the student borrower to have adequate credit history and income, or else a creditworthy co-signer.

The Beginnings of Proprietary School Loans

Following the financial crisis in 2008 that was spurred, in part, by the lax lending practices that drove the subprime mortgage boom, lenders across all industries instituted more stringent credit requirements for private consumer loans and lines of credit.

Many private student loan companies stopped offering their loans to students who attend for-profit colleges, as these students have historically had weaker credit profiles and higher default rates than students at nonprofit colleges and universities.

These moves made it difficult for proprietary schools to comply with federal financial aid regulations that require colleges and universities to receive at least 10 percent of their revenue from sources other than federal student aid.

To compensate for the withdrawal of private student loan companies from their campuses, some for-profit colleges began to offer proprietary school loans to their students. Proprietary school loans are essentially private-label student loans, issued and funded by the school itself rather than by a third-party lender.

Proprietary Loans as Default Traps

The NCLC report charges that these proprietary school loans contain predatory lending terms, charge high interest rates and large loan origination fees, and have low underwriting standards, which allow students with poor credit histories and insufficient income to borrow significant sums of money that they’re in little position to be able to repay.

In addition, these proprietary loans often require students to make payments while they’re still in school, and the loans can carry very sensitive default provisions. A single late payment can result in a loan default, along with the student’s expulsion from the academic program. Several for-profit schools will withhold transcripts from borrowers whose proprietary loans are in default, making it nearly impossible for these students to resume their studies elsewhere without starting over.

The NCLC report notes that more than half of proprietary college loans go into default and are never repaid.

Recommendations for Reform

Currently, consumers are afforded few protections from proprietary lenders. Proprietary school loans aren’t subject to the federal oversight that regulates credit products originated by most banks and credit unions.

Moreover, some proprietary schools claim that their private student loans aren’t “loans” at all, but rather a form of “consumer financing” — a distinction, NCLC charges, that’s “presumably an effort to evade disclosure requirements such as the federal Truth in Lending Act” as well as a semantic maneuver meant to skirt state banking regulations.

The authors of the NCLC report make a series of recommendations for reforming proprietary school loans. The recommendations advocate for tough federal oversight of both proprietary and private student loans.

Among the NCLC’s favored reforms are requirements that private student loan companies and proprietary lenders adhere to federal truth-in-lending laws; regulations that prohibit proprietary loans from counting toward a school’s required percentage of non-federal revenue; implementing tracking of private and proprietary loan debt and default rates in the National Student Loan Data System, which currently tracks only federal education loans; and centralized oversight to ensure that for-profit schools can’t disguise their true default rates on their private-label student loans.

Other proposed reforms the NCLC supports include modification of federal bankruptcy laws and expansion of federal student loan debt relief programs.

The NCLC argues for a modification of current bankruptcy laws that would allow student borrowers to discharge onerous student loan debts in a bankruptcy petition without having to meet the current, nearly-impossible-to-satisfy “undue hardship” tests. Amidst more relaxed bankruptcy rules and strengthened non-bankruptcy alternatives, the NCLC maintains, fewer borrowers would find themselves hopelessly mired in student loan debt.

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