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Watch out for high-cost ‘shadow student loans’

These high-cost, high-risk lenders can set you up to fail.

Anna Serio
Anna Serio

Updated

Fact checked

The Student Borrower Protection Center (SPBC) released a study that uncovered a market of high-cost student loans mainly targeting students at for-profit universities — what it calls “shadow student loans”.

The SBPC found that lenders and for-profit schools often worked together to offer loans that came with interest rates as high as 36%. That’s close to seven times as high as the most expensive federal loan this year.

These lenders targeted borrowers who also couldn’t meet the typical requirements of most private lenders. This made them more likely to default. And when students couldn’t repay, they both engaged in aggressive debt collection practices, like withholding student transcripts.

How to spot a ‘shadow student loan’

There are several warning signs you might want to look out for, especially if you go to a for-profit school.

The school is pushing a private lender

Do you attend a for-profit Title IV school that offers federal aid but suggests you apply for a private loan? This should set off your alarm bells. The SBPC found that some for-profit schools ask students to take out private loans to cover up practices that could lose them their Title IV designation.

Federal loans are generally lower-cost, come with more repayment flexibility and are available at the same rate for all borrowers, regardless of credit type. Most legitimate lenders and schools alike recommend that students fill out the FAFSA before even considering a private loan.

No credit check or cosigner

Private lenders that advertise they don’t check your credit or income — and don’t require a cosigner — can be a sign of a predatory student loan provider. But this comes with some exceptions. Providers that specialize in funding nonresidents usually rely on other metrics, like grades and projected salaries.

Unusual fees

Most legitimate private student loans don’t come with fees at all. And those that do typically only charge a fee after you’ve received your funds — called an origination fee.

The SBPC study found that shadow lenders often charge origination fees in addition to some uncommon charges. These can include nonrefundable application fees or monthly processing fees.

High APRs

With most private student lenders, interest rates rarely top 12% APR — which includes both interest rates and fees. But many of the lenders that this study looked at had interest rates that started above 12% APR and went as high as 36%.

If a lender will only tell you the interest rate but is tight-lipped about any fees, this could be a sign of a high APR.

High penalties for missing a repayment

Look into the fine print of your loan contract before you sign. Shadow lenders often have clauses that allow for highly aggressive debt collection practices.

For example, they might have a clause that states the school will withhold your transcript or suspend your certification if you fail to make repayments. These also tend to include arbitration clauses, which mean that you can’t sue the lender if you have a dispute.

Consumer protection law violations

Federal law prohibits lenders from requiring borrowers to sign up for autopay. But the SBPC found that some of these providers required borrowers to sign up to have repayments automatically deducted from their bank accounts before they accepted the loan.

Watch out for this and any other violations of the Consumer Financial Protection Act.

If anything else seems out of the ordinary, investigate. The SBPC found that some of these lenders have unusual underwriting practices, like requiring borrowers to apply for — and then get rejected from — another private lender.

Consider the alternatives first

Most financial aid advisors will suggest applying for federal aid before you even consider private student loans. If your school is eligible, fill out the FAFSA as soon as you can. This can also open you up to more scholarship and grant opportunities from your state and local government. And it can help you qualify for free financial aid from other companies.

But even if your school isn’t eligible for federal aid — say you want to go to a coding bootcamp — there are other options. You might want to rethink your program if you can’t afford it. Some offer scholarships and grants that cover the cost of attendance so you can avoid student debt altogether.

Others might offer an income-share agreement, where you attend for free in exchange for a percentage of your income over a number of years. These can be a better deal than student loans if you plan on entering a low-paying sector. But if you land a high salary, you could end up paying more than your degree originally cost.

If you do decide to borrow, go in as an informed consumer. Look out for the red flags we’ve already mentioned. And stay away from lenders that aren’t transparent about the costs.

Photo: Getty Images

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