Wednesday, May 12, 2010

Is There a Case Against Loan Certification?

by Andrew Gillen

Certification (requiring the consent of colleges before students can take out loans from private lenders) is making the rounds, and “Everyone Seems To Agree With This One

As stated in the letter,
The goal of school certification is simple: Assure that borrowers use private education loans only after exhausting less expensive federal, state, and institutional aid.

Requiring school certification that confirms students’ attendance and loan eligibility — as is currently required on all federal student loans — discourages unnecessary borrowing which could lead to delinquency and default during repayment. It also gives financial aid administrators an additional opportunity to counsel students about less expensive forms of financial aid…
Since I’m having a rough week already, and misery loves company, I thought I’d be contrarian just for the sake of being contrarian and try to make the case against requiring private student lenders to be certified by colleges.

The goal is pretty untouchable – anyone borrowing from private lenders before maxing out federal loans is either woefully uninformed or being defrauded. That leaves me with the mechanics of how you would actually implement certification, which allows for two big objections.

The first objection is that colleges have no business interfering with arrangements between other private parties. It is not the responsibility of colleges to monitor and approve of every financial decision that students make, nor would anyone like it if they tried. However, this objection suffers from a serious flaw because under current law, private student loans are not typical private transactions – they have special bankruptcy protections because they are supposed to be used for educational expenses. While my view is that private student loans should not be protected in bankruptcy, in the world we live in, they are. As long as that is the case, it makes sense to take extra steps to ensure that the student needs* the private student loan and that they use it for their education, and to do those, some type of certification/oversight by the college is called for.

The second objection is that this could lead to corruption like we saw with the preferred lender lists in the late FFEL program. We’ve seen time and time again that private lenders are not above offering bribes, and employees at public, quasi public, and private colleges are not above taking them. If the interests of students and administrators diverge again, the “additional opportunity to counsel students” may not count for much.

To combat this, the discretion of financial aid administrators over which lenders are certified needs to be all but eliminated. Some set of clear, easily observable, and publicly available criteria would need to be established, with no room for subjective interpretation.

An ideal world would not need certification because private student loans would be dischargeable in bankruptcy. Since we don’t live in that world, it is possible that certification would be a net benefit, but unless there are adequate safeguards against corruption, it is not a foregone conclusion.

*”Need” is used very loosely here. I really don’t see why the current limit on federal loans of $31,000. Combined with any grants, scholarships, savings from summer and part time work, and parental assistance, this isn't sufficient to finance an education.

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