It was almost four years ago, but it's still fresh in the minds of Americans, especially those who are still living with the fallout of the subprime lending crisis. Some estimates put the total value of subprime mortgages over $1 trillion. Two factors led to the crisis that resulted in a historic $700 billion bailout to mitigate the effects. First, banks lowered their standards. The amount of subprime mortgages is usually around 8%, but this number rose to a national average of more than 20%.

SEE: Who Is To Blame For The Subprime Crisis?

Second, American households were running up debt. In 1990, the ratio of debt to disposable income was 77%. By the end of 2007, it had raised to 127%. These two factors, along with a peak in the price of homes, led to the crisis. Some believe there may be another crisis brewing and it involves another form of subprime loans. Although not nearly the size of the mortgage crisis, subprime student loans have hit noticeable levels and have some experts worried.
The total amount of student loans outstanding reached the $1 trillion mark in 2011, but that pales in comparison to the total amount of mortgages: $10 trillion during the subprime crisis. Just like the mortgage crisis, it only takes a small percentage of the loans to default to have a crippling effect.

Many Parallels
The Consumer Financial Protection Bureau (CFPB) has its collective sights set on one segment of the student loan market, which the CFPB believes held the same lending policies as mortgage brokers at the time of the crisis. Private student loans were aggressively marketed to students and families who didn't qualify. Today, with some of these students now graduating from college, paying back these high-interest loans is proving difficult.

With half of all recent college graduates unemployed or employed with minimum wage jobs, their debt burdens are high compared to their incomes. Students holding private loans are finding it more difficult to handle the financial burdens of the loans. Students with federal loans have payment options that most private loans do not. Federal loans have flexible repayment plans that include suspension of payments for students who don't immediately find a job, loan forgiveness after so many years of on time payments, and repayment options tied to income level.

Where federal and private student loans are similar are their rules on defaulting. Unlike the subprime mortgage crisis where a person's home could be foreclosed, student loans don't allow for default - except in rare circumstances.

SEE: Student Loan Debt: Is Consolidation The Answer?

The CFPB found that just as mortgage lenders have tightened their lending standards, private student loan lenders have done the same. CFPB director Richard Cordray recommended some changes in his report to Congress to further protect borrowers.

First, require private lenders to coordinate with schools before lending to a student. This would help to keep loan amounts as low as possible to meet the needs of the student. Second, review the bankruptcy code and determine if private loans should be eligible for discharge.

Third, clarify the definition of a private loan so students and parents understand the difference between federal and private loans. Finally, clarify the overall debt obligations of the loans, including the provisions for repayment.

The Bottom Line
Although small compared to the subprime mortgage crisis, the CFPB wants to clarify the differences between private and federal loans in order to avoid a repayment crisis similar to the events of 2008 and 2009.

SEE: College Loans: Private Vs. Federal

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