What Does Student Loan Reform Mean For You?

As expected, the U.S. House passed legislation yesterday that takes a giant first step towards major federal student loan reform. The Student Aid and Fiscal Responsibility Act (“SAFRA”) includes ending the Federal Family Education Loan Program (FFELP), in which the government paid subsidies to private lenders to provide education loans to college students, and moves all federal student loans into the Education Department’s own Direct Lending program.

This shift (if SAFRA or something similar also gets passed in the U.S. Senate) would be the biggest federal student loan reform in more than 30 years. If you’re watching all the developments in the news, it sounds like a very big deal. And it is — to the FFELP private-sector lenders who have been profiting from federally-guaranteed student loans for many years. Except for maybe the opportunity to be a selected loan servicer, commercial lenders will be cut out of the federal student loan picture after July 2010.

But what would this student loan reform mean for you? Will it change the way you get federal student loans, or make them harder to get?

Actually, the system overhaul approved yesterday doesn’t change the federal student loan eligibility rules, application process, or repayment process as far as the college student borrower is concerned — it only changes the source of the money that gets loaned out. If you’re a college student in need of a student loan, you would still apply for federal loans — the best deal you’re going to get — by filing a Free Application for Federal Student Aid, or FAFSA, every January.

It will be up to your school and the U.S. Department of Education to be ready to efficiently process your January 2010 FAFSA through the Direct Lending program. Fortunately, if the SAFRA overhaul is made law, it will include providing you with a simplified FAFSA next January.

Read more about these changes would mean for you: SAFRA: What’s In It For You?

Why undertake such massive student loan reform at all?

SAFRA’s supporters, which include President Obama and education officials in his administration, believe that cutting out the middle-man (the commercial student-loan lenders) will save the government about $87 billion over 10 years. Education officials plan to put $40 billion of that savings directly into the Pell Grant program, boosting both the maximum amount of each Pell Grant and the number of grants available.

Other portions of the savings are targeted towards higher education programs designed to simplify the FAFSA, maintain low student loan interest rates, provide support for colleges that serve minorities, and increase college degree completion, Perkins Loan availability, and student loan forgiveness.

The case for closing down the FFEL Program and changing to all Direct Lending

Commercial student-loan companies, private-sector banks, and student loan trade organizations worked with sympathetic legislators to offer an alternative to the SAFRA, but as yesterday’s vote demonstrated, they were not successful. Their concerns about how much money SAFRA will actually save may not be unreasonable, but the FFEL Program has had more than a couple of strikes against it in recent years.

  • CBO Savings Estimates. The Congressional Budget Office estimated that the FFELP supporters’ counterproposal would save the federal government much less money than the SAFRA Direct Lending proposal. It could be that it’s a question of “Whose math is the right math?” but for now, the SAFRA advocates have come out ahead.
  • Student Loan Default Rates. In 2007, the rate at which students defaulted on FFELP student loans was actually higher than that of students who got loans through the Direct Lending program. This is a real blow to commercial banking institutions, who have often claimed that the premiere customer service private-sector lenders provide to students results in a lower FFELP default rate. The higher default rate is probably due to the increase in the number of students from for-profit schools getting FFELP loans, but it’s too late now.
  • Student Loan Scandal. In 2006-2007, an investigation into the student loan business uncovered extensive and dramatic corruption involving many large and small lenders from the FFEL program. The widespread conflict-of-interest violations and kick-backs between schools and financial institutions forced a federal crack-down on both the private and federal student loan industries.
  • Credit Market Collapse. Many Republican legislators and banking industry advocates characterize the elimination of the FFEL program as another example of “government takeover,” but the truth is, the federal government has been the primary funder of federal students loans for over a year anyway. When the credit market collapsed and financial institutions stopped making loans of any kind, students trying to line up money to go back to school panicked. The federal government stepped in and both took on the debt of existing FFEL student loans provided by lenders who fell apart, and increased federal funding in order to increase federal Stafford loans.

The 2009 student loan reform is not official yet. The U.S. Senate has to approve the plan, too, and the two houses of Congress often do a little negotiating to come up with a final plan that will make the majority and the president happy. Education legislators in the Senate are already at work on a plan that looks likely to pass.

Stay tuned to EducationGrant for further developments, and in the comments section, drop in your questions about what this student loan reform would mean for you.

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