Student loans are poised to become the next big consumer debt debacle. Total outstanding student loan debt is expected to top $1 trillion this year, more than double the amount owed just five years ago. That would push it well above the amount of credit card debt outstanding, which totaled less than $800 billion last November and is down nearly 17% since peaking in 2008, according to the Federal Reserve.
Partly as a result, the default rate on student loans is now far higher than on credit cards, too. According to the U.S. Department of Education, nearly 9% of student loan dollars were in default in fiscal 2009, up from 7% in 2008, the latest figures available. The default rate at for-profit colleges was even higher, at 15%. By comparison, the charge-off rate on credit card loans was 5.8% in the third quarter of 2011, down from more than 10% in 2009, according to the Fed.
The situation is only expected to get worse. A fourth-quarter 2011 survey by the Professional Risk Managers' International Association found that two-thirds of its members expect delinquencies on student loans to increase. That was up 19 percentage points just from the previous quarter. Only 8% expect delinquencies to decline.
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These figures indicate that credit unions and other lenders will be kept very busy collecting on defaulted student loans in the years ahead. Yet the very nature of student loans requires lenders to treat borrowers differently than they would other types of consumer loans.
Because student loans are unsecured and not backed by collateral like home mortgages and auto loans, borrowers don't risk losing property if they default as they would in a home foreclosure or auto repossession. That's not to say that lenders don't have some leverage over borrowers. Unlike credit cards and other unsecured loans, government-insured student loans are not dischargeable in bankruptcy court, possibly subjecting the borrower to years of wage garnishment until the debt is satisfied.
With the average amount of student debt for the class of 2010 topping $40,000, many times the average credit card debt, credit unions can't afford to wait until the borrower stops paying and the loan goes into default. Often, it's already too late to act.
Therefore, lenders and loan servicers must be more proactive in collection and contact efforts. The best way to handle this burgeoning problem is at the outset, before the first payment is even due.
Usually while the student is in school there is very little communication between borrower and lender. So the first step your credit union should take is to remind the borrowers of their obligations and that they must now start repaying the loan. The best time to do this is shortly before the loan deferment period is about to end, usually six months or less after the student leaves school or graduates from college.
This preemptive engagement is critical, but it needn't be–nor should it be–confrontational. On the contrary; it should be done with empathy and understanding. After all, you're merely reminding the borrowers of their obligations and putting them on the right path to loan repayment from the very beginning. However, borrowers need to be made aware that failure to repay a student loan could damage their credit rating for years to come, making it more expensive and difficult to get other types of loans.
Just as credit unions want to keep homeowners in their homes and drivers in their cars, the goal of early engagement with student loan borrowers is to get them to understand their obligations and help them build healthy financial and credit habits that will last them a lifetime.
Justin Meece is director of sales at National Creditors Connection Inc.
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