The Three Rs of Private Student Lending

Jim Holt
January 23, 2012 | COMMENTS

Attributed to a toast given by British Parliament member Sir William Curtis in 1825, the three Rs were long known as the foundations of a basic skills-oriented education program. While reading, 'riting, and 'rithmetic may be obsolete in today's era of standards-based education, this simple concept can still be a valuable tool for credit unions when considering the opportunity in private student lending.

Reading

We've all seen the headlines. Ever-increasing college costs have left students and families searching more than ever for affordable college financing options. According to one recent survey, 46 percent of families borrowed money to help pay for college. The federal government's Stafford and Perkins student loan programs are the most widely-used student loans and remain the best and cheapest way for students to borrow. In addition, President Obama's recently announced plan to lower monthly payments for federal student loan borrowers is another positive step during challenging economic times.

However, students and families also rely heavily on private student loans to fill funding gaps, with 13 percent of families utilizing them in 2010, versus just 8 percent two years earlier. With the average cost of attending a four-year, in-state public college at $17,131 per year (up 6 percent from 2010-11) and the average cost of a private college at $38,589 per year (up 4.5 percent from 2010-11), it comes as no surprise that families need additional financing options.

Reality check: Nearly $8 billion in private student loans were originated in 2011 and remain a critical funding component for millions of people. While the ubiquitous "student loan" moniker may mask the issue, it's important to understand these loans are a family decision, oftentimes with mom or dad playing the role of co-borrower.

Writing

As any financial institution can attest, writing loans is a risky business. Understanding that risk and employing proper mitigation tactics are the keys to portfolio performance. While private student lending is unique in many ways, it's not unlike mortgage or auto lending, in that there are important factors that can be utilized to mitigate risk. Key factors include:

• Risk-based pricing with minimum credit score requirements and criteria that strongly encourages a co-borrower
• Using school certification to verify enrollment, validate loan amount, and determine fund disbursement
• Restricting loans to students who are attending traditional 4-year schools with a proven history of low student loan defaults
• Lending "directly" to students and families within your existing field of membership to establish an opportunity for genuine, long-term relationships

For credit unions looking to eliminate risk completely, it may seem easy to refer borrowers to another lender or simply not make these loans at all. But is the answer really that easy?

• Reputation risk is inherent in any scenario where the referring credit union has zero impact on the value being delivered to the member.
• Competitive risk must also be considered. Referring loans to a bank that is aggressively pursuing consumer deposit relationships should give pause to credit unions.

Risk check:Regardless of a credit union's role in student lending, risk is present in some shape or form; understanding that all student loans are not created equal and that aligning that risk with a credit union's business strategy is essential.

Arithmetic

Delivering superior value to borrowers is an admirable goal, but it's only possible if value is also being returned to the bottom line. In 2011, the average private student loan rate on a national level was approximately 8.5 percent (variable rate that resets quarterly based on index). The average rate on private student loans issued by the 200+ credit unions partnered with Credit Union Student Choice was just a shade over 6 percent.

Quite simply, these credit unions are doing better for their members while simultaneously returning value to their balance sheet and establishing a genuine foundation for a long-term member relationship.

Rewards check: While the numbers have to make sense, the rewards can be measured in more than just ROA. Fulfilling a social role by delivering fair-value credit to those in need, establishing new relationships with young adults and families, and helping students achieve a critically important achievement in life are all part of the "mathematical" equation.

Credit Union Student Choice is the leading provider of higher education financing solutions to America's credit unions and is a preferred product provider of Credit Union Resources, Inc. Reprinted with permission from the Texas Credit Union League (www.tcul.coop).