These Student Loans Are the “Worst of Both Worlds,” Says New Report

A new report issued by a borrower advocacy organization is shining a critical light on state-based student loans.These loans, the group argues, are the worst of the worst.But this category of student loans may be poised to expand as the federal government institutes new caps and limits on borrowing under the provisions of the One Big Beautiful Bill Act (OBBBA) which Congress passed in 2025.Most student loans that are issued to borrowers are federal.

These include federal Stafford loans, Graduate PLUS Loans (which are being phased out under the recent OBBBA legislation) and Parent PLUS Loans.While none of these loans are perfect, in general, federal student loans have built-in statutory consumer protections, pathways to resolve defaults, flexible options during times of hardship and options for accessing affordable income-driven repayment (IDR) plans and student loan forgiveness (although many Parent PLUS Loans are now excluded from those options following passage of the OBBBA).Private student loans are much different.They typically have more inflexible repayment terms, higher or variable interest rates and fewer consumer protections compared to their federal counterparts.

They usually cannot be brought out of default and back into good standing if a borrower falls too far behind.And private student loans are ineligible for federal IDR plans and loan forgiveness programs.  State-based student loans are, in many ways, closer to private student loans than to federal, as they also don’t qualify for federal debt relief programs.But other aspects of these types of loans can make them even worse.Here’s why.

What state-based student loans are The new report, issued in late August by Protect Borrowers (a student loan borrower advocacy organization), highlights that state-based student loans are in a category of their own.“Most people think that there are two types of loans students can take out to attend college: federal student loans and private student loans,” says the report.“However, a third option exists: loans from state agencies or quasigovernmental nonprofits.Over half of states have some sort of state agency, legislature-created nonprofit, or other state entity that lends student loans directly to students.” These state-related lending agencies often market themselves as the good guys, said Protect Borrowers, and a comparatively better option than traditional private student loans issued by commercial lenders.

But that may not always be the case.“State student loans are marketed as coming from the government and thus signaling a more ‘trusted’ source, which is a better option than private loans,” says the report.“Their superiority to traditional private student loans, however, is questionable at best.Many state loans more closely resemble private student loans, with high and variable interest rates, limited repayment options, co-signer requirements, and harsh default provisions, than federal loans.

In fact, state student loans combine the worst of both private loans and federal loans.They have unfavorable terms and the state creditor has heightened collection powers and protections.” How state-based student loans can be problematic What makes state-based student loans distinct (and, Protect Borrowers argues, worse than any other option) is that despite being somewhat “public” loans, they are definitely not federal loans and, therefore, cannot access federal benefits like IDR plans, Public Service Loan Forgiveness, loan rehabilitation for defaulted loans and other relief programs.Their terms and conditions are usually more like private student loans, with very little flexibility during times of hardship and no option for discharge or loan forgiveness.  “Too often, state-based programs saddle students and families with loans with the worst features of both traditional for-profit private loans and federal loans,” said Sophie Laing, fellow at Protect Borrowers and author of the investigative report, in a statement in August.“These loans can lack critical rights and protections like the ability to tie your monthly bill to your income and access pathways for debt relief like Public Service Loan Forgiveness or discharge in the case of death or permanent disability.”  But state-based lenders also sometimes have even more powerful collections tools than private student loan lenders, putting them in a uniquely coercive position.

“State-based lenders have been found deploying aggressive debt collection practices, including pursuing the families of deceased students, suing students in court, garnishing wages and state tax refunds, and even revoking professional licenses,” said Protect Borrowers.“Many of these collection powers are not available to traditional private student loan lenders.” State laws usually must dictate the collections powers of state-based lenders, and these can vary across state lending authorities.But while it is not uncommon for private student loan lenders to also sue defaulted borrowers in state court, state lending authorities can be comparatively more aggressive.And state law can confer additional powers on these agencies that private lenders don’t have, like revoking professional licenses or seizing state benefits or tax refunds, depending on the state.

“These lenders wield some of the most aggressive debt collection powers in the industry—similar to those in the federal student loan program—and have been found engaging in abusive practices when borrowers fall behind,” said Laing.“State-backed private loans can be the worst of both worlds and students, families, and policymakers should beware.” State-based lending agencies may also be partially or fully immune from laws designed to protect borrowers and consumers because they are public or quasi-public entities.Usually, these consumer protection laws apply only to businesses, not state governments.This state-related immunity can limit borrowers’ options when these lending organizations engage in unfair, deceptive or unlawful servicing and collections practices.

“Many state agencies attempt to assert special protections and privileges, like sovereign immunity against borrower lawsuits and not being bound by statutes of limitations,” said Protect Borrowers.“Where courts have agreed, it’s much more difficult for borrowers to hold these lenders accountable in court when they engage in illegal activities, and to protect themselves from collection of very old debts.” State-based student loans may be poised to grow In the wake of the passage of the OBBBA, which curtails new federal student loan borrowing, state-based student lending may be poised to explode in the coming years.That’s because the OBBBA phases out the Graduate PLUS program, imposes strict new caps on Parent PLUS borrowing, and continues to impose limits on federal Stafford Loans.If federal student loans don’t cover the cost of a degree program, students and their families may increasingly turn to riskier private and state-based student loan programs.  “The One Big Beautiful Bill Act has changed the landscape of student loans, setting new, lower loan borrowing limits in the federal student loan program for students and their families,” reads the report.

“For many, these limits fall short of what they need to finance their education.To fill the void left by Congress and the Trump administration, many states and students are tempted to utilize state student loan programs.Students often turn to state agencies for funding because they seem more legitimate than private lenders.States often market their loans as a safer option for students and their families.

But as the first comprehensive investigation into state student loan programs will show, these programs often do not match the rhetoric.” “With new restrictions on federal loans, more students and their families are turning to state-based education loan providers, such as MEFA, for reliable, trustworthy, and transparent options for financing their educational goals,” says the Massachusetts Educational Financing Authority (MEFA) in a statement on its website.Protect Borrowers called on state-based lenders to improve their student loan products by offering more flexibility and options for borrowers.The group suggested that these lenders expand discharge options based on health-related disabilities, offer more generous forbearance options, provide income-sensitive repayment plans and forgo the most aggressive collections practices against borrowers who are in default.But until and unless states amend their laws to allow or mandate these practices, these lenders will not be required to do any of those things.

And in the meantime, this category of student loans is poised to grow.