Some of the nation's biggest for-profit colleges and vocational schools are boosting enrollment in tough times by making more loans directly to cash-strapped students, knowing full well many of them probably won't be able to repay what they borrowed.
The schools still make money because the practice boosts their enrollment and brings in tuition dollars subsidized by the government. But some of these students could end up saddled with high interest rates and loan payments they can't handle, a burden that could damage their credit for years to come.
Among the for-profit colleges that are booming are ITT, Corinthian Colleges and Career Education Corp. They and other such institutions have an estimated 1.2 million U.S. students pursuing degrees in such fields as nursing, computers and the culinary arts.
Many students at these schools get thousands of dollars in tuition grants under various government programs, and take out loans to cover the rest of their costs.
But because the economic meltdown has made it harder for students to get bank loans, several of these schools are increasingly stepping in, financing degrees in the same way a furniture store or used-car dealer might extend credit to customers.
These schools call the practice a lifeline for students who couldn't otherwise afford an education. And in some cases, students may find better terms than they used to get from lenders like Sallie Mae Corp., which have recently cut way back on student loans to high-risk borrowers.
But some experts worry students will get pushed into loans they shouldn't take.
In fact, two publicly owned college chains have set aside roughly half their internal lending amount as a loss reserve - essentially telling investors they don't expect students to repay more than half of what they borrow.
Another concern: Some companies label such loans consumer financing rather than student loans, which carry particular disclosure requirements. One for-profit school, Colorado-based Westwood College, has been hit with a class-action lawsuit accusing it of fraud and arguing that its lending program violates state banking laws. Westwood charges a relatively high 18 percent interest but doesn't call its lending student loans.
"It's very alarming," said Deanne Loonin, director of the National Consumer Law Center's student loan borrower assistance project. The colleges "can structure the products in all kinds of ways - things like revolving credit lines, unsecured loans, even secured loans. It's this new thing and we're worried about it."
Westwood, which has been making such loans for eight years, calls the lawsuit unfounded.
Many for-profits are seeing enrollment surge. New enrollments at ITT are up one-third from a year ago; last month the company forecast profits 50 percent higher than last year. Laid-off workers returning to school and increased government aid have boosted the number of students at many of these places.
Jessica Rosales was 17 when she enrolled at Westwood's Inland Empire campus near Los Angeles. She dropped out after one term and was later told she owed Westwood around $18,000 - nearly half in interest and collection fees. Rosales said that the school misled her about the source of her aid and that she never signed a loan from the school.
"It's basically been a curse for me," said Rosales, one of four lead plaintiffs suing Westwood. The interest charges have been dropped, but the bill remains on her credit report. She said she gets calls from collection agencies and is having trouble getting a mortgage.
Westwood's Apex loan program, which is used by about 30 percent of its 12,000 students, has no credit requirement, said Bill Ojile, senior vice president of Westwood. He said that terms are clearly disclosed, interest accrues only after the student leaves school, and students are required to exhaust all other options first.
Even critics acknowledge many for-profit schools - also called "proprietary" colleges - offer convenience and innovation that nonprofit colleges could stand to emulate. They also proudly enroll many low-income students.
But they can also be expensive. Forty-three percent of proprietary college students took out private loans in 2007-08, up from 15 percent in 2003-04, according to an anaysis of federal data by the group Education Sector. Over the same period, the proportion of students at for-profit colleges borrowing at least $40,000 nearly tripled to 30 percent, according to Mark Kantrowitz of the Web site finaid.org.
Those figures are worrisome because, on average, for-profit colleges have lower graduation rates and higher loan default rates than other schools.
Some companies, including Apollo Group, parent company of the giant University of Phoenix, have steered clear of such loans altogether, and the industry calls internal lending a relatively small practice, entered into reluctantly.
"We're not lenders. We're educators," said Harris Miller, president and CEO of the Career College Association, which represents the industry. But "if it's a question of not going to school at all or covering the gap, they cover the gap."
Some students could be better off borrowing from their school than from a third-party lender. Career Education, for instance, says most students in its lending program pay just 8 percent interest, and online students pay none. The company says it has no interest in making students overextend themselves.
So why are Career Education and Corinthian Colleges making loans so risky that they anticipate half won't be collected?
Consider, for example, a school charging $10,000, hoping to enroll a student who has lined up $9,000 in aid from the government and elsewhere. Even if the school loses half of the $1,000 it lends to get the student in the door, it comes out $9,000 ahead.
"For many of these students, if you don't apply these thousand dollars, they're not coming to school," said Jeff Silber, an industry analyst at BMO Capital Markets. "Even if you write off that $500 right away, you're giving up all those other revenues. Financially it still makes sense to do this."
Another incentive is the "90-10" rule, a federal law requiring for-profit colleges to collect at least 10 percent of revenue from sources other than the federal government. That gives for-profit colleges a reason to keep tuition high and offer loans.
According to Securities and Exchange Commission filings and comments to investors, Corinthian plans about $100 million of lending this year. ITT said last month its lending grew significantly last quarter and would total $75 million this year. Career Education said its current balance of $31 million could grow to $50 million by year's end.
Representatives for Carmel, Ind.-based ITT ESI Educational Services and Santa Ana, Calif.-based Corinthian did not respond to requests for comment.
Rosales said she wishes she had listened to her mother, who found Westwood's recruiters pushy and only reluctantly let her daughter attend the school.
"But you're young and you think you know it at all," Rosales said. "And you really don't know anything."