Lessons From the Loan Scandal

ERIC SMOLITSKY, a senior at the University of Connecticut, is a sharp guy who is spending the summer doing stem cell research. But when it comes to student loans - he will graduate ,000 in debt and plans to borrow 0,000 more for medical school - Mr. Smolitsky finds it annoyingly complicated. "I haven't spent much time looking into it," he acknowledges. "They say, ‘Here is your financial aid package.' "

Students in general have not thought much about how it all comes together (as long as the dollars are covered somehow). After all, they had a trusted adviser in the financial aid office.

Such assumptions have been shaken by recent disclosures about financial aid officers receiving junkets, consulting fees and kickbacks courtesy of the loan industry, owning stock in loan companies and steering business through "preferred lender" lists. A report from Senator Edward M. Kennedy, released last month, details how a lender's place on the list at the University of Texas, Austin, had more to do with what "treats" were offered the financial aid director than what rates were offered students.

"Students and families had assumed that the advice they were getting on financial aid and loans from college officials was based on that person's experience and knowledge and on what would work best for that student," says Robert M. Shireman, president of the Institute for College Access and Success, in Berkeley, Calif. Mr. Shireman points out what is now obvious but was once unthinkable: colleges and financial aid officers can have "competing interests."

Legislation is pending in Congress, and the Department of Education has proposed rules governing the relationship between lender and college.

Now new concerns have surfaced about whether lenders use fair criteria to assess applicants for private, or "alternative," loans. According to the College Board, such loans accounted for 20 percent of educational borrowing for the 2005-6 school year, up from 4 percent a decade earlier.

Ultimately, all this attention should benefit borrowers. But for now, students (and parents) scrambling to get loans for next year's tuition bills must navigate this intimidating and labyrinthine industry.

"My wife and I are both college-educated, and we sit there and say, ‘How are kids supposed to do this?' " says David Robinson, who lives in Lexington, Mass. A project manager at I.B.M., he is helping his son apply for student loans, find part-time work and otherwise cover the ,500 it will cost him to attend Merrimack College in September.

Despite money from a 529 college savings plan and scholarships for both academics and athletics (lacrosse), David Jr. will need ,000 a year in loans. Mr. Robinson co-signed a private loan application at Sallie Mae but was stunned at the interest rate - 10.25 percent plus a 3 percent fee at repayment. "I think that's too expensive," says Mr. Robinson. "I find this an extremely daunting, nerve-racking process. You don't know now what you are getting into."

If the student loan scandal has made some wary, it has also provided a prod to get smart before borrowing.

Sam Is Your Best Rich Uncle.

"You should never get a private student loan unless you have exhausted your government student loans," says Mark Kantrowitz, the publisher of FinAid

.org. Post-scandal, that fact is displayed prominently on lender home pages.

Private loans, which carry variable rates, can come with double-digit interest (and no cap). Interest on federal loans, on the other hand, is set by Congress 5 percent for a Perkins (for the neediest students), a cap of 6.8 percent for a Stafford (for any income level) and 8.5 percent for a PLUS (for parents and graduate students).

"Why would anyone ever get a private loan?" wonders Mr. Kantrowitz, author of "FastWeb College Gold: The Step-by-Step Guide to Paying for College."

The answer is that Perkins and Stafford loans have limits on how much can be borrowed, and despite plans in Congress to raise those limits, loan amounts can fall well short of college costs. As for undergraduate PLUS loans, parents might not qualify (unlike Stafford and Perkins loans, a PLUS requires a credit check, so a loan default, a credit card delinquency or a bankruptcy can sink an application). Or parents might not warm to decades paying off their child's debt.

Mr. Robinson thought it would be good for his son to get a private loan as a way of investing in his own future. Also, he says, with three other children to raise and educate, "I didn't want to totally be on the hook for it."

For Rates, Expect the Worst.

Shopping for a mortgage? Flip to the newspaper's business section for a chart comparing rates. But in the student loan industry, which has grown fast and unchecked, rates for private loans are all over the map. Lenders have developed their own criteria for assessing borrowers with unknown future income, no collateral (like that house to foreclose on) and brief (if any) credit histories.

In short, the greater the likelihood of default, the higher the interest rate.

Credit score is the biggest factor in determining the rate, but every lender judges differently the risk that you won't pay back what you borrow.

Laura Pappano is a writer-in-residence at the Wellesley Centers for Women at Wellesley College.