Many months into the credit crisis, times remain tough for many student-loan seekers. But hopeful signs of a thaw are emerging.

Students who rely on private student loans continue to see their options dwindle. Several of the nation’s largest banks have either shut down or significantly reduced their private student loan programs.

Still, the news isn’t all bad. Recently, the private student loan market has shown some small signs of life.

“(Investors) are still staying away, but there are some promising signs,” says Mark Kantrowitz, publisher of the financial aid Web site and the scholarship search service

Meanwhile, families seeking federal loans are finding success. One bright spot in particular has been the large-scale implementation of the federal Ensuring Continued Access to Student Loans Act of 2008.

ECASLA has kept Stafford and PLUS loans flowing to students despite the trouble in the financial industry, says Jason Delisle, research director for the education policy program at the New America Foundation, a public policy think-tank in Washington, D.C.

“It is fully in place, and lenders are taking full advantage of it,” Delisle says. “Financing for the majority of federal student loans are being made through that program.”

The state of student loans
  1. Private loans still scarce.
  2. Federal loans still available.
  3. Stafford loan have risen.
  4. Some fall through cracks.
  5. Alternative options.

Private loans still scarce

The Project on Student Debt, a Washington, D.C.-based nonprofit agency dedicated to curbing student loan debt, estimates that 14 percent of all undergraduate students currently rely on private loans to foot at least some of their college bill.

In recent months, private loans have become difficult to find, especially for students and families with bruised credit.

“Universally, lenders have stopped making loans to people with FICO scores under 650,” says Kantrowitz “That’s essentially eliminating 10 percent of the pool that was previously being approved. My best guess is that 100,000 families at least are going to be denied private student loans that previously would have been eligible for them.”

The primary reason lenders have backed out is the continued fallout from the subprime mortgage crisis. To finance a student loan, most lenders, especially nonbank lenders that don’t have customer deposits to rely on, don’t front the money themselves. Before the credit crisis, they could take out short-term loans with credit warehousing facilities. Once the lender had amassed a significant number of loans — at least $100 million worth, according to Kantrowitz — the loans were securitized and sold to investors at a premium.

“They do that because credit warehousing facilities are very expensive, and by using investors, it’s actually a cheaper source of funds,” Kantrowitz says. “Unfortunately, when securitized subprime mortgage loans started defaulting, investors pulled out of all forms of securitization, including student loans. With the capital markets no longer being a source of funds, these lenders don’t have money coming from anywhere, so a lot of them had to stop doing private student loans.”

Kantrowitz offers the example of the College Loan Corporation, which saw Citigroup refuse to increase its warehousing facility to accommodate new lending. As a result, College Loan Corporation stopped offering new private student loans.

Despite such gloomy developments, the private student loan market has begun to perk up a bit recently, Kantrowitz says.

“Sallie Mae did a $1.5 billion deal with Goldman Sachs, and there’s been talk of Sallie Mae bringing a private student loan securitization to market,” he says. “Also, Sallie Mae made some changes in their private student loan program that may ultimately make it easier to securitize private student loans, despite the current icy capital markets.”

Federal loans still available

Families taking out federal loans, including the Stafford and PLUS loans, are in a safer position, explains Sallie Mae spokesman Conwey Casillas.

Passage of ECASLA has given federal loans a new boost. The legislation increases the Stafford loan limit to $31,000 total, boosting the amount students can borrow each year by $2,000. It also offers new, more flexible payment options and helps borrowers with damaged credit to get PLUS loans.

Federal loans also are easier to find because they carry fewer risks for lenders. Unlike private loans, federal loans are backed by the U.S. Treasury, making them guaranteed safe investments for lenders who can front the cash. Although a number of smaller nonbank lenders have pulled out of offering federal loans due to problems coming up with the upfront capital, recent legislation allows lenders to sell loans to the U.S. government.

“Instead of using the capital market to raise funds to make new loans, lenders can now sell them to the government and proceeds from that sale would go to fund new loans for the upcoming year,” says Casillas.

This program – originally intended to expire in 2009 — has been extended for another year in an effort to keep larger federal loan lenders in the student loan game until the capital markets turn around.

With an increasing number of lenders folding, students who attend so-called Federal Family Education Loan, or FFEL, program schools — institutions that direct students to outside lenders for their federal loans — may have to switch lenders in the upcoming 2009-2010 year.

However, Delisle says families who do their homework and hunt around for a lender should be able to secure a federal loan.

“There are a lot fewer lenders out there who will make student loans,” Delisle says. “But we don’t know of any single case where a student has not been able to get their federally subsidized student loan,” Delisle says.

Students who attend direct lending institutions, where funding comes directly from the government and the school acts as the loan originator, won’t be affected at all.

No matter where they attend, students relying on federal student loans in the upcoming school year should check with their financial aid officers to make sure their money will keep coming through.

Stafford loan limits have risen

The option that will impact the most students is increased Stafford loan limits. Starting last school year, students who qualified for Stafford loans were eligible for $2,000 more per year than they were in years past. That means dependent freshmen are eligible for $5,500 ($7,500 for independent students), $6,500 for dependent sophomores ($10,500 for independents), and $7,500 for juniors and above ($12,500 for independents).

ECASLA also raised the lifetime Stafford loan limit to $31,000 for a dependent undergrad ($57,500 for an independent undergrad) and left the limit at $138,500 for a graduate or professional degree student, all at a 6.8 percent interest rate — significantly lower than the 12 percent to 14 percent rate many private lenders charge.

Some fall through cracks

Even with the new aid increases, Robert Shireman, former executive director of the Project on Student Debt, now the deputy under secretary for postsecondary education for the Obama administration, says that some students — namely those with high tuition bills and bad credit history — will still fall through the cracks as private lenders back out of offering alternative loans.

“There will probably be some students who have tapped out their Stafford loan eligibility and who can’t convince their parents to take out a PLUS loan,” Shireman says. “If they need more money beyond the Stafford limits and they can’t find a good co-signer, that situation would be difficult.”

Students who attend foreign institutions and unaccredited U.S. schools that don’t qualify for federal aid may encounter problems as well.

“My understanding is that those are some of the schools that the private lenders don’t even want to deal with,” Delisle says.

The hardest-hit students may be those attending community, junior and technical colleges, where the loan amounts run much lower and the default rates frequently run higher than for borrowers at four-year universities.

“I have heard stories at some schools where it’s harder for their students to get loans, and some of the lenders have been making changes in the way they make new loans,” says Barry W. Simmons Sr., financial aid director for Virginia Polytechnic Institute and State University in Blacksburg, Va. “I think there have been some isolated cases, but we won’t feel the full impact until we see what happens in fall enrollments.”

Alternative options

While most higher education institutions aren’t setting aside funds specifically for casualties of the student loan credit crunch, Simmons says students who find themselves in a cash crisis should immediately head to their school’s financial aid office. In addition to providing information about unadvertised school-specific scholarships and grants, a financial aid office may be able to direct students to a different lender that can accommodate their needs.

Peer-to-peer lending sites are also a definite option,” says Kantrowitz. Eliminating the need for banks, co-signers and credit approval, sites like and allow students to ask a wide network of friends, family — even strangers — for small fixed-rate student loans repayable after graduation. Generally the peer-to-peer lender is responsible for keeping track of who owes what to whom, collecting the funds and distributing the payments to those who fronted the money in the first place.

Kantrowitz says that while peer-to-peer sites may not work for students who need to raise vast quantities of college cash, they are viable alternatives for students with bad credit who need a few thousand to get them through until graduation.

If all else fails, take a look at low-cost education alternatives, says Joe Hurley, founder of the financial aid Web site (a subsidiary of “Students can save a lot of money by spending two years at a community college then transferring to a four-year school,” says Hurley. “If they can’t find a loan, they should consider switching to a different school that’s going to cost less or offer a better financial aid package.”

Until lenders start jumping back into the private student loan game, those with college costs beyond what the feds will cover will have to rely on a mish-mash of funds from their school, community, or network of friends and family. “Unfortunately we can’t offer one single solution for students who lose their loans,” says Simmons. “There are no black-and-white answers for this.”

Claes Bell contributed to this report.