Credit unions seeking to forge lifelong ties with young borrowers are increasingly offering private student loans to help them bridge the college funding gap.

Private student loans earned a bad reputation in the mid-2000s when unscrupulous lenders hooked unwary youth into loans they could not pay. Like other securities bundled for investors seeking high profits in the mid-2000s, these loans melted down in the Great Recession.

In a climate of tighter regulation, credit unions stepped in more aggressively, including through two CUSOs: Credit Union Student Choice, based in Washington and founded in 2008, and CU Campus Resources, based in Madison, Wis., and founded in 2010. CUSOs allowed credit unions to manage the regulatory risk, and provide an easy entry into the market for credit unions with limited resources.

Student Choice handles loan origination, school certification, processing and long-term loan servicing for about 250 credit unions. Credit unions control their rates and lending criteria, according to Jim Holt, its chief development officer.

“In essence, we act as the credit union's outsourced student loan department. We handle the most complex and time-consuming aspects of student lending,” Holt said. “We also provide hands-on support in the critically important areas of member education, compliance and marketing.”

Both Student Choice and CU Campus Resources report healthy returns. Return on average assets for Student Choice clients is between 3% and 4%.

“These earnings are determined through customized pricing, as set by the credit union, in conjunction with strong performance,” Holt said.

For just those loans in full repayment, Student Choice client credit unions have less than a 2% delinquency rate and 1% annualized gross charge-off rate.

The volume of private student loans has grown more than four-fold in the last seven years.

The market has been created by the widening gap between college costs and federal assistance. Stafford College Loans provide only about $5,500 to $7,500 per year to students who are dependents. Independent students can borrow more under the federal loans.

The average yearly cost of attending a public four-year college was $18,110 from 2013 to 2014, nearly double the cost of tuition, fees, and room and board 20 years earlier after adjusting for inflation, according to the U.S. Department of Education.

The average American under 35 now has $17,200 of student debt, 182% more than Americans of the same age had in 1995, the Fed data showed.

“A college degree has become a necessity for financial success, but it has become a real challenge to pay for education,” said Debbie Taverna, vice president of lending at Digital Federal Credit Union in Marlborough, Mass. ($7.2 billion in assets, 580,055 members). DCU was one of the founding investors in Student Choice in 2008. “We're here to help them fill the gap.”

Yet, Mike Long, president and COO for CU Campus Resources, said the extent of the student debt problem has been misunderstood.

For one thing, students leaving school with $25,000 in student debt owe less than they might after buying a new car.

And while the popular impression has been that debt problems stemmed from high costs for four-year programs, researchers have found defaults have been disproportionately high among those attending for-profit schools and community colleges.

The problem with for-profit schools was highlighted in a report last year that found most defaults since 2000 came from borrowers attending for-profit schools. These schools enrolled about 12% of college students, but accounted for nearly half of student loan defaults.

“There was a tremendous rise in enrollment at for-profit and two-year institutions during the last 10 to 15 years, and unfortunately, many of these borrowers did not attain a degree or able to secure better employment or a higher wage,” Holt said.

From 2005 to 2009, unscrupulous lenders were pushing loans on students who were sometimes attending for-profit schools with high fees, low entrance standards and little track record of success.

Since then, most credit unions began vetting the schools, and schools vetting the lenders.

“A lot of the bad lenders have been pushed out of the market,” he said.

The risk to the reputation of credit unions was highlighted in 2014, when the CFPB sued ITT Educational Services for an alleged scheme to trap low-income students into high-interest loans they were unlikely to ever be able to repay. The scheme involved a CUSO created by ITT and supported by six credit unions. Neither the CUSO nor the credit unions were named in the suit.

Today, private student loans make up roughly 7.5% – or $102 billion – of total student loans outstanding. The remaining 92.5% of the $1.36 trillion in total student loans are federal loans.

Private student loans are credit-based loans underwritten by lenders who assess a number of factors, including ability to repay, before making a decision to lend. Roughly 94% of undergraduate private student loans included a cosigner during the 2015 to 2016 academic year, and 61% of graduate private student loans included a co-signer. The vast majority of cosigners are parents and other close family members.

Both CUSOs stress educating members before lending, a practice that helps build trust and improves chances of success for borrowers.

“We work hard to properly educate members and families on the importance of gaining a degree and borrowing the least amount possible,” Holt said. “We do this by informing them to exhaust grants and scholarships (the free money) first followed by federal loans. Surprisingly, close to half of all private student loan borrowers do not exhaust all of their federal loan eligibility.”

This type of service costs money, but is still often lower than the cost of originating some types of loans processed in-house, Long said.

Some CUSOs charge a flat rate. Some charge a percentage of the amount financed. UW Credit Union, a client of CU Campus Resources, pays an origination fee equal to about 0.5% of the loan amount.

CU Campus Resources also offers a private student loan refinance program. It allows members to consolidate existing student loans for a lower interest rate or extend repayment terms.

UWCU in Madison, Wis., ($2.2 billion in assets, 214,452 members) began offering private student loans in 2006. When laws changed after 2008, the task became more complicated and the CUSO CU Campus Resources was formed. Long, who was then and is now chief credit officer at UWCU, also took on leadership of the CUSO.

UWCU now has $126 million in student loans, equal to about 6% of its assets.

The program took a dent during the Great Recession, but recovered and has brought healthy returns to members. The 5.4% yield on those loans is about twice the rate for auto loans, Long said.

So far they have performed well. Out of more than 50,000 loans, only 0.67% are delinquent and 0.2% have been written off.

The program lends only to students attending accredited not-for-profit schools, and it ensures through the school that the money lent matches the amount the student needs.

“We're not giving them more than they need,” Long said.

About 90% of its loans have parents or others as co-signers.

The loans charge about 7.5% annual fixed interest, with rates under 3% for variable-rate loans.

Credit unions often complain they can't capture the youth market. But they also don't support a product young people need: Student loans, Long said.

Long suggests the loan portfolio should represent 3% to 10% of assets.

“I'm not saying credit unions should put all of their eggs in one basket, but they should definitely devote a certain percentage of their balance sheet to this product,” he said.

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Credit Unions Bridge Student Loan Gap

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