What’s Driving the Decline in Private Student Loan Default?

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Positive news on the student loan front! Private student loan default – specifically, defaults of 90 days or more – are on the decline. According to data compiled by Moody’s Investor Service and reported by Collections&CreditRisk, the rate of people with private loans staying in default past 90 days has dropped to 3.4%.

So the question is, why are students and graduates defaulting less? And what can be done to maintain and even improve upon this positive trend? Before we answer these questions, it’s important to understand why private student loans are so challenging in the first place.

The Challenge of Private Student Loans

While it may seem that private student loans shouldn’t be much different from federal student loans, the differences are many – and important. Here are just a few:

Private student loans may require immediate repayment.
While federal student loans don’t require repayment as long as you’re enrolled in classes full-time, the same can’t always be said for their private student loan counterparts. Some private student loans may actually require you to begin repaying immediately. This will simply depend on your lender and their terms of service. But given the fact that full-time students often can only work part-time at most, this is a huge disadvantage they’ll face in their finances right from the get-go.

Private student loans can come at a higher interest rate.
Federal student loan interest rates can be consolidated upon graduation and have a rate increase cap. However, private student loan interest rates can fluctuate at the will of the lenders. So while some private student loan lenders advertise a lower rate than federal loans, that doesn’t necessarily mean the rate is fixed. If it’s not fixed and does balloon up, you could be looking at some credit card-like interest rates on your student loans. A scary thought to be sure. Meanwhile, other private lenders start out at a much higher rate in the first place. Remember, student loan amounts will be quite a bit larger than any other debt you take out (other than a mortgage), so that interest rate matters – a lot.

Private student loans do not carry the same assistance options as federal student loans.
Finally, private student loans simply don’t carry the same amount of assistance and forgiveness options that federal loans do. For example, with federal loans, you are guaranteed certain deferment and forbearance options, as well as alternate repayment plans like IBR. If you were able to obtain a loan with a grace period and at a lower rate than federal, then this might not matter. But the standard repayment plan for a student loan is 20 years. A lot can happen in that time frame. The assistance that federal loans give you during tough times can be a game changer for your finances; and private student loans simply haven’t built in this type of forgiveness structure yet.

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For these reasons, we generally recommend that private student loans should be taken only when federal student loans won’t cover the bill. However, every person has a different situation, for which we share some more pros and cons here.

Decline in Private Student Loan Defaults

There are a multitude of reasons student loan borrowers go into default: from the types of loans they borrow (federal vs. private), to the types of schools they attend (traditional vs. for-profit), to their ability to get and maintain gainful employment after graduation. The latest data would suggest that the decrease in defaults at 90+ days is due to a decrease in unemployment.

It’s pretty clear as to why unemployment leads to default. If you can’t find a job or are underemployed, keeping a roof over your head would take precedence above all else. And there’s no question that college graduates faced a significantly higher rate of unemployment after the Great Recession of 2008. While unemployment numbers are improving, they still aren’t quite back to what they were prior to 2008. That means this positive trend of student loan defaults decreasing depends on the improvement of other economic indicators.  The study mentioned in Collections&CreditRisk seems optimistic:

“’The performance of student loan deals continues to improve year over year,’ said Moody’s Assistant Vice President and Analyst Stephanie Fustar, author of a fourth-quarter report on the sector. “’But the default rate will remain higher than it was before the recession, so as long as unemployment, a key driver of student loan defaults, remains high. Moreover, even as the unemployment rate improves, high student loan debt, persistent underemployment and lower earnings will continue to make it difficult for graduates to make their loan payments.’”

College is all about getting an education that will turn young adults into well-rounded adults who have opportunities for the best possible future. The increase in college students year by year, combined with a less than stable economy, means that promise of a brighter future is not as certain as it used to be. Now is the time for graduates to take matters into their own hands – and many are! That means doing everything possible to find work (especially work that can jumpstart your career), creating opportunities when there are none to be found, and staying educated on all of your financial options. With creative solutions and help from the recovering economy, here’s hoping that things will continue to look up for college graduates.

Image credit: diego_cervo

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