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Many Private Loan Borrowers Forgo Less Expensive Federal Options, ACE Analysis Finds

Aug. 21, 2007

One out of five undergraduate private loan borrowers did not take advantage of federal student loans that offer lower interest rates and more flexible payment options, even though these students appeared to be eligible for this aid, a new issue brief by the American Council on Education (ACE) finds.

Who Borrows Private Loans? analyzes data from the Department of Education's National Postsecondary Student Aid Study. It examines the rapid growth of private student loans and answers some important questions about borrowers including their academic and demographic profiles; the other types of financial aid they receive; and the share of students who forgo federal student loans in favor of private loans.

Borrowing through private loan programs totaled $17.3 billion in 2005-06, accounting for 20 percent of all education borrowing and making them the fastest growing component of student financial aid. The share of undergraduates borrowing private loans has grown from less than 1 percent in 1995-96 to 5 percent in 2003-04. 

Because federal loans offer a low fixed rate, no interest charges while enrolled for qualified students, and flexible repayment options, most experts advise students to borrow the maximum amount available through the federal program before turning to private loans. "Since financial aid experts agree that private loans should be used as a supplement to federal loans, it is alarming to find that so many student borrowers aren't taking advantage of the less expensive federal option," said Jacqueline E. King, director of ACE's Center for Policy Analysis and author of the issue brief. 

According to King, there are several possible explanations for the high percentage of student borrowers who relied solely on private loans.  Half of private loan borrowers with no federal loan did not file a FAFSA (Free Application for Federal Student Aid), the application for all federal loans as well as most types of grants. These students are particularly troubling to King because a significant percentage of them may have qualified for federal, state, or institutional grant aid, thus reducing their need to borrow. 

Other possible explanations cannot be confirmed with existing data. Private loan borrowers who did not use the federal program may simply have been attracted to these loans because of the way they are marketed. They may have been attracted to the application process for private loans, which typically is simpler and easier than completing a FAFSA. The FAFSA is eight pages long and contains more than 100 questions. Students also may not have been aware of differences in cost between the federal programs and private loans, and may not have either sought out or been able to find an objective comparison of the costs and benefits of their various options. 

Some students borrow private loans because they are ineligible for federal loans, but these students were excluded from the analysis.

Among the other highlights of the issue brief:

• 80 percent of private loan borrowers are undergraduates. Most undergraduate private student loan borrowers attend full time.
• 75 percent of undergraduate private loan borrowers attend one of three types of institutions: public four-year colleges and universities (30 percent); private, not-for-profit four-year colleges and universities (30 percent); and for-profit institutions offering programs of two years or more (15 percent).
• Most private borrowers have federal student loans as well. Seventy-seven percent of private student loan borrowers also had a Stafford federal student loan, however 21 percent of those students borrowed less than the maximum amount. 
• Private borrowers are disproportionately dependent students. At public and private not-for-profit four-year colleges and universities, they are also disproportionately from middle-income families.
• After grants are deducted, private loan borrowers at each type of institution face higher average educational expenses than their counterparts who do not borrow these loans.

"The private loan industry has experienced tremendous growth over the past few years and has recently been under the watchful eye of Congress and the New York attorney general, so understanding who uses these loans is more important than ever," King added.