So, how would I do it?  After the student ran the calculations before they could get to the results, I would have these sentences flash on the screen:

• Your loan is a variable rate loan and your payment amount will vary based on your interest rate, which is based on an underlying index, LIBOR + your margin
• LIBOR is currently at 0.25%
• Historically, LIBOR has ranged from 0.25% to 9.125% over the last two decades with an average of about 4.5%
  
• Based on this historical ranges (which are no guarantee of future results), your monthly payment may vary from X to Y
• Using your starting interest rate as the assumption of the interest rate over the life of the loan will lead to an underestimate of your total loan cost. 

Anyone want to take a shot at simplifying further?

Congratulations for making your ninth on-time payment, your loan rehabilitation is now complete...the principal amount on your loan is now 18.5% higher

I haven't seen the notice that goes out to a borrower who has their student loan rehabilitated but I imagine that I am not far off with the verbiage described above.  A quick lesson on loan rehabilitations...recall that a student loan borrower defaults on their loan after not making payments for 270 days (which by the way seems a bit long to wait for that designation, I wonder how many borrowers make payments after they have been delinquent for 180 days).  At that point, their credit in tatters, they are provided a "lifeline" called rehabilitation.  All they have to do is make on-time payments over the next 9 months to have their loan put back into good standing.  The dirty secret is that the borrower can negotiate the amount of this monthly payment to increase their odds that they can reach this nirvana for borrowers with defaulted student loans. 

Unfortunately, here is where it gets interesting.  Now that they have gotten back on track, they find out that for this privilege of making these 9 on-time payments and having their credit cleared, they are assessed a fee as high as 18.5% of the principal balance on their loan.  The guarantor who has managed this rehabilitation then sells the loan to the federal government and capitalize on that 18.5% fee.  In case you were wondering, guarantors rehabilitated $3.5 billion of loans in 2009, potentially yielding $648 million in fees that were assessed on borrowers.  With student loan borrowers struggling, it is time for a second look at this practice..here is a suggestion, keep the rehabilitation, eliminate the fees.  Oh and one other question that taxpayers might be interested in, since they are buying these loans with their 18.5% fee premium attached:  Does rehabiliation really work?

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So, what was the surprise?  I didn't expect to see that proprietary schools, on a percentage of enrolled student basis, have three times more Pell recipients than public 2-year institutions (community colleges).  So, I thought I would turn to an expert on community college financial aid issues, Debbie Frankle Cochrane from The Institute for College Access and Success (here is their issue brief on student access to federal student loans at community colleges), who emailed me this response today:

Now back to the question of the demographics of the borrowers at each of these institutions.  With almost 100% of students at for-profits borrowing (the figures for 2007-08 for for-profit institutions were 93.1%), it seems reasonable to assume that about 2/3 of their borrowers could be characterized as low income (based on having received a Pell Grant).  Meanwhile the comparable figures at community colleges indicate that 37.2% of these students took out loans for 2007-08.  So, the upward bound of low-income borrowers at community colleges would appear to be just below 50%, if all Pell Grant recipients (18% of their enrollment) took out a federal student loan.  So, based on this rough analysis, it would appear that a higher percentage of borrowers at for-profits (about 66%) fit a low-income profile as compared to borrowers community colleges (where at most 50% would appear to be low-income).  So, the 31% differential in 3-year cohort default rates between the proprietary and two-year publics seems to match pretty closely with the 32% differential in the percentage of their borrowers that are low income at the respective institutions. 

One morning, I checked my email to see this message from a student: 

I contacted the student directly to collect some additional information:

• Student had maximized federal grants, federal loans and scholarships.
• Student had four loans with this lender that had been taken out in prior years (she is in her final year of school).  She sent me her statements showing that each of these loans were at 4.25% (Prime + 1%) currently and also that she was making regular interest payments on these loans during the in-school period (which was not required by this lender).
• Student's current loan was priced at 11.625% (almost 750bp higher than her rate just one year ago).
• Cosigner on her loans said nothing had changed in his/her financial condition.

Here is the appeal letter that the student sent to her lender back in September: 

After following up the appeal letter with a phone call, she was told to fax the letter to the lender.  After waiting three days, she called and was told by a manager that in order to be eligible for a loan with a lower rate she would need to apply again.  Her solution:  she got off the phone, applied for a loan at Discover Student Loans and secured a rate of 10% (may have been able to get an even lower rate at one of these credit unions). 

Now some might say the student was naive in not understanding that the game had changed in the credit markets in the ensuing twelve months and that she should have known that rates on her next student loan would go up.  And to be clear, Citibank is certainly not unique among student lenders in increasing the margins on their loans at the same time they have increased their underwriting standards.  If the student had been really diligent and perused Student Loan Corporation's (Citibank's student loan subsidiary) and been able to read between the lines the latest quarterly earnings announcement, she may have been able to discern why her interest rates had changed so dramatically:

Boy, it is one thing to read statements like this and another to think about what this means for the thousands of borrowers, who might have qualified in earlier years for a loan and now can't get a loan from "their" lender or can only procure one at steeply higher rates.  For those lenders who believe that their franchise value exists in just being there for students (regardless of the interest rate they charge on their loans), the cautionary tale here might just be that borrowers are becoming more interest-rate savvy and willing to shop around.  And that would be a good thing!

Before diving into the conference call, I thought I would wade into their supplement to their earnings call (Oh no!  I am having flashbacks to my time as an investment analyst and creating those earnings models!).  The supplement shows how their guaranteed student loan business grew by over $1 billion and private loans by almost $500 million in the past twelve months (or about a 5% share in an $11 billion private loan market).  Figures shown below are loan balances at quarter end expressed in thousands of dollars):  

Note:  Private loan balances are based on assumption of 70/30 mix between federal and private loans, which Discover confirmed in the call today. 

Here are excerpts from a transcript of their 4Q 2009 conference call today (thanks to Seeking Alpha):

• Disciplined growth in student loans: 

• Note that two of the leading players in the private student loan market, Sallie Mae and Citibank, saw loan originations in the most recent quarter drop 58% and 47% respectively.
• Wells Fargo noted in their 3Q conference call that their private loan originations were up 10% YTD. 

• 2/3 to 70% of student loans made are of the government guaranteed variety; private loans focused on 600 schools: 

• On mix of federal vs. private loans and profitability of private loans: 

• May participate in loan participation and purchase financing programs for federal student loans originated by FFELP lenders for 2009-10 (Discover did not participate in those programs in 2008-09):

Also, in their 4Q earnings announcement released earlier today, they noted that their student loan portfolio grew by $513 million, which based on earlier ratios (70% federal/30% private) suggests about a $150 million increase in private loans over the September to November period:  "The student loan portfolio grew $513 million in the quarter while credit card loans decreased $670 million."

If you did not receive a copy of the survey and would like to participate, please feel free to send me an email at tranzetta@studentlendinganalytics.com. 

"One of its insights is particularly relevant to today's environment: the impact of split servicing, the condition in which a borrower's loans are serviced by more than one entity. Dr. Woo concluded that this condition increased the likelihood of default by 22%. For years, lenders, guarantors, and secondary market holders took pains to try to serialize a borrower's loans to one servicer, and a single servicer was the norm for most borrowers. With ECASLA purchases and the transition to DL, split servicing will affect the approximately 50% of borrowers whose loans are not currently serviced by Sallie, Nelnet, AES, or Great Lakes."

Please send along any other studies that you might be aware of on this topic.  It would certainly seem a good investment to update this study to inform policymakers as to the causes of student loan defaults, given their accelerating growth. 

Why is this important?  A recent research report from Public Agenda on college completion found that 2/3 of those who dropped out of college before completing had thought a lot about going back to school but been constrained by concerns about working and going to school at same time.  78% of students surveyed also indicated that schools could help by offering more courses in the evening and on weekends so that students could continue working while taking classes. 

It will be interesting to see how other colleges pursue this opportunity to get former students to the finish line.