Private college loans gain popularity
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Some schools consider costs when choosing top lenders. Others look for those with high approval ratings. There's no standard on how colleges pick, says Dallas Martin, president of National Association of Student Financial Aid Administrators. "There's a variety of things colleges look at and we try to encourage them to look at the comprehensive picture. Whether or not everyone does, I can't answer that."

That's not good enough for Senator Dick Durbin. The Illinois Democrat recently called for a federal investigation into conflict-of interest deals between lenders and universities following increasing press reports that schools are getting inducements for helping drum up loan business.

Laws prohibit inducements to colleges in the federal loan program, but no such regulations exist for private loans.

"The student should know whether their school is receiving an inducement in exchange for the loan," Durbin wrote John Higgins Jr., the Inspector General of the U.S. Department of Education.

University of America Inc.
Meanwhile, some schools are getting into the private loan business themselves. American University in Washington, D.C., for example, works in cooperation with Bank of America to offer the American University Educational Loan. It's managed by First Marblehead, a company that specializes in custom-branded college loans.

American University requires Bank of America to limit interest rates at competitive prices, says Brian Lee Sang, director of financial aid at American. Specifically, American won't let Bank of America charge more than a margin of 3.6 percentage points over the LIBOR rate -- a total of 8.95 percent at current rates.

By comparison, says Sang, many other private loans charge the prime rate plus a margin of 3 to 4 percentage points more for a total of roughly 11 percent to 12 percent at today's prices.

"We're forcing them to take less of a profit," says Sang.

Even so, Sang admits private loans, including American University's, "aren't the best form of financial aid. They should be used only when absolutely necessary."

Instead, Sang "really encourages the PLUS over this (school) loan." It's cheaper, and it comes with a fixed rate, so prices stay in check. Not so with the American University product, which is variable.

Sang's pitch for the PLUS may never be heard by borrowers.

When loans feature a school brand, students and parents alike assume it's the best deal, say critics such as Alan Collinge, founder of Student Loan Justice in Washington, D.C., an advocacy group.

"Students innately trust their universities," says Collinge. "They see the name and trust it's in their best interest to get the loan. But there may be other lenders who are willing to give better terms."