College Students Hit by U.S. Credit Crisis

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The credit crisis is being felt in all financial areas, especially the federal loan program for college. Three major banks have pulled out of the program, with several other non-bank lenders to follow. Financial expert Alvin Hall talks about loans, college and smart money management for college students.

MICHEL MARTIN, host:

We'll take a look now at the other challenge to education today - paying for it. We knew we needed a money coach for this, so we've called on our personal finance guru, Alvin Hall. Across the country, students are eyeing their mailboxes for college acceptance letters. But after that good news, just how will they pay for the schools of their choice? Last week, several banks pulled out of the Federally Guaranteed Student Loan Program. Other lenders are reducing their participation.

This follows last year's decision by Congress to cut lender's subsidies by more than 20 billion dollars over five years. Here to help us sort all this out and tell us what this means to us as individuals is our money expert, Alvin Hall. Hi, Alvin.

ALVIN HALL: Hello, Michel.

MARTIN: Alvin, three of the biggest lenders - HSBC Bank, M&T Bank, and TCF Financial Corporation decided not to participate in the federal loan program anymore. Why?

HALL: I think because they saw risk associated with the loans equal to the risk associated with the mortgage crisis. Because today most of these loans are repackaged, very similar to the mortgages, and then sold on to lenders, they started to worry that maybe some of these people are the same people who have mortgages, who have over-extended their credit, and therefore will not be able to pay back their loans.

MARTIN: Do you have any idea what impact this has on the available money for student loans?

HALL: So far, it's pretty regional. If your university or lending officer depended on one of these banks for loans, it does have a knock-on effect. But I think a more important affect of it is that reduces the number of lenders and therefore the cost the borrowing, especially if you have to go outside of the federal system, will go up.

MARTIN: Why can they do that? Can they just opt out?

HALL: It's completely their option. It's a business decision. They decided that the business is too risky. They can back out at any time they want to. The government does not demand that they stay there through thick and thin.

MARTIN: What is the government's role then here?

HALL: The government role is really to try to make as many loans available to people as possible. But there are several ways you can do this. You can go to the direct student loan route, which means you borrow directly from the government, which is probably the most efficient way that most people should do it. They should go to the bank that has access to those kind of loans, or some other lender, and borrow directly from one of those.

Then you can do the private route. The private route is where you go to a bank, and a bank makes you the loan themselves, but that is not guaranteed or backed by the federal government in any way whatsoever. And that's often very risky.

MARTIN: Does the - are there income guidelines or income restrictions on who can participate in the federal loan program? I guess what I'm wondering is why wouldn't everybody participate in the direct lending from the federal government. One would assume that the rates would be favorable because there's no profit motive.

HALL: The rates are favorable. Some people don't know about it. Some universities and smaller colleges don't participate in it to the extent that they could. And there are some income ceilings placed on this. Basically, any student that needs money can get a loan from the federal government. And parents, through a separate program, can also borrow money from the fed up to the full amount of the student's need requirements minus aids.

But therein, Michel, lies the little twist. Provided they've had no adverse marks on their credit records, then parents can borrow. These days, with the credit tightening, people need to look at their credit reports before they apply for loans.

MARTIN: Are you concerned that qualified students who have been accepted to the colleges of their choice will not be able to go because they won't have access to the loans?

HALL: As you asked me that question, a knot came into my stomach because I recall when I applied to schools. I was one of those kids out there who needed money, and I look at the programs today, and I think if a kid is really determined and the parents are really determined, they'll find access to that money. But I think there are parents and students out there who don't understand how credit works, who don't have good credit ratings. They will be damaged by this.

MARTIN: Is home equity a big source of college financing? I guess what I'm wondering is is the overall credit crisis likely to affect the student loan market as well?

HALL: Yes, it will drive the costs of borrowing up. People will have a more difficult time tapping into their home equity to pay for schools. It's just going to get tighter for people to get loans, and people need to sit down before they ever look at the packages and start doing some work to see if they need to borrow, what are the greatest sources. There's some great websites out there. But also I know that several of the bigger schools with huge endowments have completely eliminated loans. So I think that if a student is very bright, they're very motivated, they should definitely apply to one of those schools.

But barring that, they should borrow much more judiciously. Try to keep it as low as possible. If they can pay the interest over the time they're in school, or their parents can, that will help save them money. Do whatever you can to keep the costs of your education low. And I tell everybody, maybe you want to start out at a smaller school these days. You may want to go to an expensive school, but if you can't afford it and you don't get a good enough package, go to a school you can afford.

Be brilliant in that small pond and then transfer to the school you want to and get a better package.

MARTIN: So finally, Alvin, give us some take away tips on what students can do to secure their college financing.

HALL: Start by looking at the types of loans you have available. Look at those made directly by the fed that you can borrow, that your parents can borrow. Look at the income ceilings required. Look at the amounts you can borrow. Also, if you're really desperate, look at private loans, although I would not encourage people to do that. Decide how you're going to pay for your day-to-day expenses. Will you get a job while you're in school? Your role, if you really are motivated to get an education, is to figure it out.

MARTIN: Alvin Hall is our financial expert. He joined us from our New York Bureau. We'll have a special Q and A on our website, npr.org/tellmemore, with tips from Alvin talking about the credit crisis and what else you need to know. Alvin, thank you so much.

HALL: You're most welcome.

MARTIN: I'm Michel Martin. You're listening to Tell Me More from NPR News.

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Answers to Frequently Asked Questions about U.S. Credit Crisis

by Financial Expert Alivin Hall

How did the Credit Crisis start?

The credit crisis started when people who had taken out mortgages they could not afford, or that had been incorrectly marketed to them, began to default on their mortgage payments. In the old days, when banks held people's mortgages this would have been bad for the banks. But, today, these mortgages have been pooled together and "sliced" by brokerage firms and other financial services companies into bond-like securities that were then sold on to institutional investors. The prevailing marketing point of view was that these securities were "safe." However, as interest rates rose and more and more people defaulted (stopped making regular payments) on their mortgages, there was no money flowing into the pool to pay the institutions who bought the bond-like securities. Huge amounts of these securities began to drop in value because there would be no money to make the payments. Then it was revealed which companies held the most of these securities. And the huge write downs began. In reaction to the staggering losses, banks and other financial services began to tighten credit for everyone. The period of easy credit came to an end.

Why did one part of the mortgage business — subprime loans — have such a widespread effect?

While, statistically, subprime mortgages represent a small part of the overall market, when people began to default on them, the markets got scared, and with reason. All of the securities were, at least in terms of the financial models on which they were created, supposed to be safe. They proved not to be. What if similar securities, using the same or similar mathematical models, were also not as safe? Would they also began to lose value soon? The domino effect began as people left the market and banks decided to reduce their risk by demanding the people who bought securities on margin (credit) deposit more money to maintain the position.

Why did Bear Stearns take such a hit?

Like many financial institutions Bear Stearns funds much of its day-to-day operations pledging securities that it owns with the promise of buying the back later at a higher, pre-negotiated price. It also is the counter-party (opposite side) in some trades, for which it may earn a fee. When the rumor started that Bear was in trouble, firms stopped wanting to trade with Bear Stearns because its creditworthiness had been compromised. With no one to trade with, the cash flows that normally sustain a firm came to an abrupt and unexpected halt. It was either merge, or go bankrupt. And if a firm the size of Bear Stearns, the fifth largest investment bank in America, went bankrupt, the repercussions in the financial markets in the U.S. and around the world would have been unpredictable, which is a nice way of saying it would not have been pretty for any of us.

What has the Federal Reserve done to ease the crunch?

The Fed has lowered interest rates in an attempt to avert more defaults on the variable rate subprime and other mortgages. And it has opened the "window" through which Federal Reserve banks have traditionally borrowed money to the brokerage firms. In short, the investment banks can now borrow money directly from the Fed. This will hopefully prevent the cash flow problems that Bear Stearns encountered with its counterparties.

How long will it last?

Who knows? The Fed and the government hope it begins to improve by the summer. But just look at all of the people who have lost their jobs, or been laid off as a result of this, and you have to wonder if his big, complex situation can be turned around in a few months. It took more than a few months to create.

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