Understanding the New Federal Law

Buried deep in the package of health care reforms that became law March 30 are provisions that promise to shake up the student loan industry.

By eliminating taxpayer subsidies to corporate middlemen who marketed and originated federal student loans, the changes will raise more than $60 billion over the next 10 years, with the savings being spent on more and bigger grants, easier repayment terms and even a little deficit reduction, the Obama administration says.

After stripping banks of their role as middlemen in the federal student loan process, the government is now the primary lender to students.

Buried deep in the package of health care reforms that became law March 30 are provisions that promise to shake up the student loan industry.

By eliminating taxpayer subsidies to corporate middlemen who marketed and originated federal student loans, the changes will raise more than $60 billion over the next 10 years, with the savings being spent on more and bigger grants, easier repayment terms and even a little deficit reduction, the Obama administration says.

Here are answers to the most important questions students and parents may have about the new loan landscape:

How will the student loan reforms affect students wishing to take out federal loans for college?

Most student borrowers won’t notice much difference, since most of the changes are behind the scenes. If anything, the new system will be simpler and less confusing. Starting July 1, no student will be asked to — or have the opportunity to — shop for a Stafford loan, the most common kind of student loan available to all citizens attending undergraduate or graduate programs at least half-time.

All colleges will arrange for students to take their federal Stafford loans directly from the government. The biggest immediate downside for students is that some won’t get the small discounts that certain lenders offered on Stafford loans. But all undergraduates will continue to be eligible to borrow Stafford funds of at least $5,500 (and, depending upon their age and year in college, up to $12,500) at an interest rate that cannot exceed 6.8% a year.

Students who qualify as “needy” will continue to be able to borrow at lower rates of interest. All graduate students will be eligible for Stafford loans of up to $20,500 a year at an interest rate of no more than 6.8%. Graduate students will also continue to be able to borrow their full cost of attendance (less any other financial aid) through the Grad PLUS program at an annual rate of no more than 7.9%.

How will the student loan reform bill affect parents wishing to take out a federal PLUS loan?

The bill could make things easier for many parents. Starting July 1, parents will be able to borrow PLUS funds directly from the federal government only.

How will the student loan reform bill affect students who need financial aid?

It will make more grant money available to more students. By stopping subsidies to private companies that made Stafford loans, the federal government will raise money that it will use to fund more and bigger Pell grants, which typically go to students from families earning less than about $45,000 a year.

In many cases, this will save parents money because the direct federal PLUS rate is capped at 7.9% a year, while private lenders often charged as much as 8.5%. In addition, some research shows that the federal government was more lenient on parents who had credit problems and less likely than private banks to reject parents’ PLUS applications.

How will the student loan reform bill affect graduates attempting to pay back their loans?

It will make it easier for future graduates to pay back their student loans. Starting with federal student loans taken out in 2014, future graduates will be able to sign up for an “income-based repayment” plan that will cap their monthly payments at 10% of their income. Anyone paying back federal student loans now can sign up for the current IBR program that caps payments below 15% of income.

In 2010–11, the maximum Pell grant will rise $200, to $5,550. The bill also calls for some future Pell grant increases to be made according to the consumer price index. By some estimates, the maximum Pell grant could rise to $5,900 over the next decade.

Will this reform really cause the loss of up to 31,000 jobs, as its opponents (mostly private lenders) claim?

No. This is just a shift in who makes the loans. Since, if anything, the demand for federal student loans is likely to increase, there will still be plenty of need for workers to process and handle the loans.

The federal government is already arranging to contract with many existing loan companies to service the future loans. The only significant layoffs are likely to be among the salespeople who lobbied colleges to choose a private bank as a “preferred lender.” As painful as that will be for the individuals, that’s a savings for students because it means there is no more incentive for the kind of kickback arrangements that led to recent scandals, notes Jason Delisle, the director of the Federal Education Budget Project for the New America Foundation.

Besides, if the federal government can make more loans with fewer people, that’s an improvement in efficiency that saves taxpayers money, Delisle adds.

Mark Zandi, the chief economist for Moody’s Analytics, says, “There should be little job impact from this legislation, and any job losses that do occur will be the result of improved productivity.”

Is this a federal “takeover” of the student loan program?

Only a little. Until now, the federal government guaranteed the private lenders that made Stafford and PLUS loans that it would repay 97 cents on the dollar for loans that go into default. Now the government will make all the loans, thus taking on the last 3% of the risk, and keep the billions of dollars it used to pay to private companies for making the loans.

The Congressional Budget Office estimates that that’s a good deal for taxpayers, with the net gain to the Treasury totaling more than $60 billion over the next 10 years. Private lenders and banks will no longer get paid by the federal government to make the federally subsidized and guaranteed student loans, but they will still be free to raise private capital from investors and make private loans.

This article was reported by Kim Clark for U.S. News & World Report.