AAMC Reporter: June 2008

As the Economy Flags, Student Lenders Close or Suspend Business

After sustaining heavy losses from mortgage securities and other areas, several lending companies are pulling out of the student loan business, creating uncertainty among medical schools and students, some of whom have been forced to find new lenders to finance their education. The nation's economy is struggling, and lenders are among the companies that have been hardest hit.

Reduced government subsidies for student loan programs are adding to the woes of the student financial aid industry. In the past several months, approximately 20 private loan companies and 50 loan providers affiliated with the Federal Family Education Loan Program (FFELP), a partnership through which the government allows private lenders to provide federally guaranteed loans, have suspended business. Sallie Mae, the nation's largest student loan company, has eliminated about 1,000 jobs in the past six months because of the market situation.

"Our model ceased to be functional," said Dan Thibeault, M.B.A., president and cofounder of private lender Graduate Leverage. "We really didn't have a choice."

Thibeault said his company operates by initially offering loans to students, and then transferring them to the secondary market, where investors purchase securities or assets from other investors. When these secondary players stopped buying the loans, Thibeault said his company had to close.

Thibeault said he hopes to be back in business "as soon as the market starts functioning as it has been for the last 40 years."

In the meantime, the loan business suspensions have clear implications for students who rely on borrowed monies to pay for their higher education. Although there is little evidence that students have been denied FFELP loans—which generally have lower interest rates than private loans—some have been forced to switch lenders when their current provider pulled out of the market. Students at schools using the government's William D. Ford Federal Direct Loan Program (FDLP) borrow directly from the U.S. Department of Education and are relatively unaffected by these market circumstances. Students at community or for-profit colleges, on the other hand, are more likely to lose their lenders.

Medical students are considered to be among the least risky customers in the higher education loan field because of their high earning potential and proven repayment track record. However, the financial aid community is concerned that changes in the market may affect medical students overall, said Shelley Yerman, AAMC student record and financial aid program specialist.

"There is a great deal of uncertainty, and some schools are worried about getting loans for their students if the lenders pack up," Yerman said. "But at the same time, all students have been able to find new lenders."

At Wake Forest University School of Medicine, most medical students did not have to find new lenders for their FFELP loans during the 2007–2008 academic year, but Financial Aid Director Melissa Stevens said many rising second-, third-, and fourth-year students will have to switch lenders for the upcoming school year. All this change, she said, is causing students to knock on her door with questions.

"One student asked me, 'Should I panic?'" Stevens said. "This is not the norm, and it means some confusion for students."

According to Stevens, communication efforts are underway to assuage students' concerns. Initially, she said, the school touched base with students through e-mail, and now offers open forums about how students can prepare if they need to switch lenders.

At the University of California, San Francisco (UCSF), School of Medicine, Director of Student Financial Services Carrie Steere-Salazar said that even though 33 health professions students had to switch lenders when Graduate Leverage suspended FFELP participation, they were able to transfer loans fairly easily.

"Graduate Leverage did pull the plug on disbursements shortly before the spring semester, so it was more disruptive for students than if it had been at the end of the year," Steere-Salazar said. Students, however, could switch lenders online, and the company was efficient in canceling loans so students could quickly apply for new ones, Steere-Salazar said.

Switching lenders does not come with an extra price tag, but students with FFELP loans could suffer financially due to recent cuts to the program, Yerman said. Last fall, Congress slashed $22 billion in federal subsidies for student loan providers over a five-year period as part of the College Cost Reduction and Access Act of 2007. This move, according to lenders, put them in a fiscally precarious situation. Even companies that did not shut down have taken away certain long-term borrower benefits, such as monetary rewards for on time payments. Plus, fewer lenders in the market means less competition—and less reason to offer incentives to potential borrowers.

"An unintended consequence of this legislation is that medical school is ultimately going to cost our students more, even if they don't change lenders." Stevens said.

Thomas A. Kelly, a spokesperson for lending giant JP Morgan Chase, said the company will continue offering FFELP loans to medical students, but will no longer waive the 1 percent origination fee medical students pay when they first borrow the loan.

"This means very little change for medical students," Kelly said.

In response to the lenders' suspensions, President George W. Bush recently signed into law the Ensuring Continued Access to Student Loans Act of 2008, which calls for the government to buy loans that lenders have struggled to sell to investors. This would create liquidity for lenders to make new loans, ensuring students and their families have access to federally backed loans, even if the marketplace contracts significantly.

—By Elissa Fuchs