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Sallie Mae Enters Private Lending: More Debt to Come?

HI5-27-13 HI6-6-13For some time we’ve been reporting in this space about the emerging crisis in student loan debt and its impact on various sectors of the economy – including housing. And because the student loan situation in some ways parallels the events of the 2008 housing collapse, what helps or harms underwater student borrows has the potential to affect the fortunes of investors following Jason Hartman’s recommendations to build wealth in real estate.

Now, in a move reminiscent of the evolution of federal mortgage entities Fannie Mae and Freddie Mac, student loan megalender SLM Corp, affectionately known as Sallie Mae, is announcing plans to split into two different, publicly traded entities. One of these will continue to service traditional, federally funded student loans, while the other will devote itself to the increasingly lucrative area of private loans.

Before the housing crash, borrowing for home purchases was easy and prices were high – a combination that lured many homeowners into taking on the debt of mortgages they couldn’t manage, That caused the massive wave of foreclosures and short sales that left the housing market reeling.

Something similar has been happening in the student loan industry. As tuition rates began to climb at virtually all institutions, student loans were offered not just by industry leader Sallie Mae but many other lenders, to virtually every student who applied. Like subprime mortgages, student loans were offered on deferred or interest-only payment planes, or tied to borrowers’ post-graduation income.

With college costs hopelessly out of control, degree seekers were led to believe that taking out student loans was the only option. And now, as tuition costs continue to rise, the private loan market is expanding too, promising to cover costs that federally funded student loans don’t – at interest rates and terms that are often far higher than those on traditional loans.

The upward spiral of college costs and loan amounts leads some financial experts to fear a bubble is about to burst, just like the housing bubble did. And that’s why Sallie Mae’s move to create an entity capable of servicing more lucrative private loans to unwary students and their families is cause for concern. Like the housing collapse before it, the student loan collapse would have a ripple effect throughout many other areas of the economy.

As we’ve noted in previous posts on the reasons investors should watch the student loan issue, recent grads saddled with massive debt don’t buy homes, or take out loans for other reasons Many can’t get work in their degree fields and, unable to pay down their loans, end up defaulting, ruining the credit needed to apply for a mortgage. And cash-strapped students become renters who may default on rent too, leaving landlord/investor empty handed.

For many students, federally funded student loans are a lifeline to higher education. With lower interest rates and deferred payment options, they’re relatively affordable and safe, unlike private loans that may set students up for failure later.

The housing collapse shows what can happen in an environment of escalating prices and unlimited borrowing. And you don’t need to go to college to see how student loan problems can become housing problems too.  (Top image: Flickr/gorogen)

Source:

Hechinger, John and Janet Long. “ Sallie Mae Split Marks Bet on Much-Abused Private Student Loans.” Bloomberg Personal Finance. Bloomberg, 30 May 2013′

Read more from Heroic Investing:

Cleaning Up Credit After Foreclosure

Reverse Mortgages: Sounding Good On Paper

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