When Banks Compete, Students and Taxpayers Win.
"There is a novel solution that could reduce student loan borrower costs: create a 'lendingtree.com' for student loans. It's what economists call a reverse auction: the sellers (banks) bid for the customers' (students') business."
-Michael Dannenberg
New America Foundation
Michael Dannenberg
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"There is a novel solution that could reduce student loan borrower costs: create a 'lendingtree.com' for student loans. It's what economists call a reverse auction: the sellers (banks) bid for the customers' (students') business."
-Michael Dannenberg
New America Foundation
Higher Ed Watch
Colleges and college aid officials have been funneling their students to big banks like Sallie Mae and Citibank in exchange for cash, gifts and in-kind benefits, according to a series of recent public investigations, the most energetic of which is being led by New York State Attorney General Andrew Cuomo.
Thus far, the investigations have resulted in the suspension of 10 higher education officials, including Columbia University's director of financial aid, the issuance of almost 100 subpoenas nationwide, and a series of financial settlements with several colleges and three student loan banks. The colleges have agreed to gift bans and a new code of conduct. The banks will contribute $6.5 million to a financial education fund.
These measures alone are unlikely to get to the heart of the problem, which is that banks don't compete for student business. Instead, they jockey for a spot on colleges' "preferred lender" lists, virtually guaranteeing that colleges will funnel students in the direction of favored lenders, regardless of interest rates. There's no incentive to ensure that students get the best deal.
There is a novel solution that could reduce student loan borrower costs: create a "lendingtree.com" for student loans. It's what economists call a reverse auction: the sellers (banks) bid for the customers' (students') business.
Here's how it would work: The Attorney General would issue a request for proposals from private and nonprofit entities to design an Internet-based reverse auction platform. Students would make known their interest in borrowing a federally guaranteed student loan. Then, lenders would bid for student business according to the percentage rate offered.
Currently, nearly all lenders charge students the maximum interest rate allowed by law. So no student would end up with a worse deal under a reverse auction system.
There's no need to worry about the banks. Thanks to a government subsidy and guarantee against default, student loans are exceptionally profitable for lenders. On the 2005 Fortune 500 list, the nation's largest student loan provider, Sallie Mae, ranked second in profits as a percentage of revenue. (Microsoft ranked 18th.)
So, make no mistake: Banks could offer far cheaper federal loans to students. In fact, one small New York company called MyRichUncle currently offers federal loans at a rate that's a full percentage point lower than Sallie Mae's. For the typical federal student loan borrower with $20,000 in debt, that translates into roughly a $1,000 savings over the life of the loan.
When MyRichUncle approached colleges to get on their preferred lender lists, it was rejected - because it didn't offer schools kickbacks, stock options, call centers or computer software like Sallie Mae's. It just had a cheaper product for students. You'd think that would be almost enough. It is in a real market.
What are we waiting for? Attorney General Cuomo should create a lendingtree.com for student loans now. Make it free of charge to any student and family in the country. And critically, as a condition of future settlements with implicated colleges and universities nationwide, Cuomo should require that they end their current preferred lender practices and instead refer students to this new reverse student loan auction platform.
The result would be cheaper loans for borrowers and fewer opportunities for colleges to compromise their ethics. Colleges shouldn't funnel kids to student loan banks - an effectively functioning market should.
Reprinted from The New York Daily News, April 19, 2007
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Sallie Mae
I wanted to know if Touro College was implicated in Coumo's investigation. I am a graduate of this college in 1999, and am still paying my student loans. Five years ago I began paying about $200-$250 more a month to pay the principal down and in this time I have paid approximately $24,000 off the original $68,000. I have asked Sallie Mae to investigate this, and they sent me a payment history.
My problem with this company is that when I graduated, I consolidated my loans at 7.625% not knowing that this would lock me in that rate for the duration of the loan. I have been contacted by numerous companies offering a lower rate, however Sallie Mae has told me they do not have to release the loan to a bank willing to give a lower rate.
It is not just students graduating with high debt, it is the fact that Sallie Mae is using unfair practices for repayment. Every student should be able to go with any bank who offers the best rate, just as you have suggested in your "LendingTree" scenario. Has anyone thought about blogging students who have graduated to boycott payment of student loans to force the Congress and Senate to write legislation and go after Sallie Mae's practices? Just a thought. Thank you for the opportunity to tell my dilemma. J. Andrew
Sallie Mae
DJ
Only Half the Story
My Rich Uncle charges borrowers the 2 percent origination fee. Sallie Mae pays it for the borrower, as do many lenders.
MRU borrowers lose the 1 percent interest rate break if they miss a payment. Which, apparently, most borrowers do.
I'm not taking anything away from MRU, but their terms are what they are.
More than borrower benefits
Only Half the Story
Also with all this talk about having Washington take over all of federal loans, how many times do you think that everytime a budget crisis happens that education will be the first thing cut? Don't be fooled. It is always the first thing cut.
From MyRichUncle
With MyRichUncle, 100 percent of students receive the up-front benefit of a one percentage point interest rate reduction from the start of repayment on federal Stafford loans and one and three-quarters percentage point interest rate reduction from the start of repayment on federal PLUS and GradPLUS loans. Our borrowers have the right to keep this discount, no matter if payments are late or forbearance is requested, for the life of the non-defaulted loan.
Our up-front discounts provide a lower average percentage rate (APR) to borrowers on their loans. In light of the rhetoric and erroneous statements about our terms that have been made, I wish to be clear that these indeed are the terms that have been and are currently offered by MyRichUncle.
Karin Pellmann, VP Public Relations, MyRichUncle
2% interest rate reduction
A 2% interest rate reduction with a delayed onset is worth less than an immediate 1% rate reduction, forgetting for the moment about any requirement for a prompt payment discount. For example, a 2% rate reduction after 48 months is the equivalent of a 0.63% rate reduction starting at repayment. When one factors in a requirement for prompt payment, with an odds of missing a payment of 1 in 36, the 2% rate reduction is worth only 0.10% on average.
Even a 2% rate reduction that does not require on-time monthly payments or involve a delayed onset, but instead requires the borrower to sign up for direct debit, is more apparent than real. Anecdotal evidence suggests that 7% to 13% of borrowers sign up for ACH. 7% multiplied by 2% is 0.14%.
A key concern for borrowers is that a preferred lender list is a general recommendation for the students who attend the school. It does not take into account each individual student's particular circumstances. If a student knows that he or she will definitely sign up for direct debit (ACH), then a 2% rate reduction that only requires one to sign up for ACH is better than a 1% rate reduction with no strings attached. But the vast majority of students would be better off focusing on immediate discounts and discounts which they can't lose, as opposed to discounts that require prompt payment behavior, since less than 6% of borrowers qualify for the full amount of prompt payment discounts.
Mark Kantrowitz, Publisher, FinAid.org
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