February 14, 2006
EFFECTS OF FEDERAL CHANGES TO STUDENT LOAN AND FINANCIAL AID PROGRAMS
By: Saul Spigel, Chief Analyst
You asked for a summary of recent changes in federal laws governing student loans and financial aid programs and their potential effects on Connecticut students.
Congress took final action on February 1 on legislation (The Deficit Reduction Act of 2005 (S. 1932)) changing federal student loan program rules and other student financial aid. The changes are effective July 1, 2006.
The changes affect both borrowers and lenders. Students (and their parents) will be affected most by provisions that raise interest rates on loans to parents (rates on loans to students were already scheduled to rise on July 1, 2006), raise borrowing limits, extend eligibility to borrow, make currently optional fees for borrowers mandatory while reducing other fees, and create two new student aid grant programs. Lenders will be affected by cuts in government subsidies and reduced reimbursement for defaulted loans. Over the next five years, the Congressional Budget Office estimates these and other changes will result in $12.7 billion in net savings for the federal government.
We cannot estimate the effects these changes will have on Connecticut borrowers and lenders. The Connecticut Student Loan Foundation (CSLF) is attempting such an estimate, which we will forward to you when we receive it.
STUDENT LOAN CHANGES IN DEFICIT REDUCTION ACT OF 2005
Loans to finance higher education come from two sources—private institutions (e.g., banks and credit unions) and the federal government. Private institutions make Federal Family Education Loans (FFEL); the US Department of Education makes Direct Loans. Under FFEL, banks make Stafford Loans to students and PLUS Loans to parents. Under the Direct Loan program, the Education Department makes the same kind of loans directly to borrowers. FFEL and Direct Loans differ principally in terms of fees and the financial relationship between private lenders and the federal government. Private institutions make FFELs available at below-market-rates. The federal government guarantees the loans through intermediaries like the CSLF at a rate determined annually by a statutory formula.
Loan Interest Rates. Under current law, both Stafford and PLUS loan rates vary annually; the former is now 5.3%, the latter 6.1%. Under legislation enacted in 2001, both rates were scheduled to become fixed at higher rates on July 1, 2006—the Stafford, 6.8%, the PLUS, 7.9%. The Deficit Reduction Act increases the PLUS rate to 8.5%.
Borrowing Limits. The act raises to $3,500 from $2,625 the Stafford Loan amount students can borrow in their freshman year and to $4,500 from $3,500 in their second year. But it keeps the total amount an undergraduate may borrow at $23,000.
Stafford loans can be subsidized (the government pays the interest while the student is in school) or unsubsidized (the borrower pays the interest during school). The act increases the annual unsubsidized loan limit for graduate and professional school students to $12,500 from $10,500.
Coupled with the increased interest rates, these higher borrowing limits mean that some students could end up with higher monthly payments because they are repaying more in interest on larger loans.
Borrower Eligibility. The act permits graduate and professional school students to take out PLUS loans. It also allows students to borrow money to attend schools that rely heavily on distance (on-line or correspondence) learning by removing a requirement that at least 50% of an institution's courses be delivered on campus.
Loan Fees. The act requires guaranty agencies to collect a fee equal to 1% of their loan balance from borrowers to offset federal default costs. Currently, these agencies have the option to charge a 1% “insurance fee,” but most do not, partly due to competition with the direct loan program, which has no fee.
The act phases out, by July 1, 2010, a 3% FFEL Stafford loan origination fee lenders pay the federal government. Lenders can charge borrowers for this fee, but, according to the American Association of State Colleges and Universities, most do not. Over the same period, the act reduces to 1% from 4%, the origination fee the Education Department is authorized to collect from Direct Loan borrowers. Currently, the department charges 3%, which it further reduces for borrowers who repay promptly.
Capturing Money from Lenders. The act achieves a large part of its savings, according to the Chronicle of Higher Education (1/6/06), from lenders. Lenders could seek to recoup some of these losses from borrowers.
Most of the savings come from a new requirement that private lenders rebate to the federal government the money that they now make when students pay a higher interest rate than the one lenders are guaranteed for participating in the below-market-rate loan program. Under current law, they can keep the money. The act also ends a loophole that ensured lenders a 9.5% return on loans backed by certain refinancing bonds.
The act captures money from lenders in several other ways. It:
1. reduces the amount the government reimburses most lenders for defaulted loans, from 98 to 97 cents of every dollar that is not paid back and from $1 to 99 cents for lenders designated as “exceptional performers”;
2. caps loan collection costs at 18.5% of outstanding principal and interest on defaulted consolidated loans (after college, borrowers can consolidate multiple loans into a single loan) and requires guaranty agencies (like CSLF) to return 8.5% of that amount to the Education Department; and
3. beginning in 2010, requires guaranty agencies to return the entire amount they collect once the total amount of their consolidation loans exceeds 45% of their total collections. (This provision is intended to discourage guaranty agencies from relying too heavily on loan consolidations to resolve loan defaults.)
Loan Defaults. The act allows the government to seize 15%, up from 10%, of the wages of borrowers who default on their student loans.
NEW STUDENT GRANT PROGRAMS
The act creates two new grant programs—Academic Competitiveness and National Science and Mathematics Access to Retain Talent (SMART) grants. These grants are in addition to the Pell Grant, which is capped at $4,050. The Congressional Budget Office estimates the new programs will provide $3.7 billion in student aid between 2006 and 2010.
To be eligible for either program, a student has to be a US citizen, eligible for a Pell Grant, and attending school full-time. The student must also have completed a “rigorous” high school curriculum, as determined by the secretary of education. A first-year student at a two- or four-year college receives up to $750. A student who maintains a 3.0 grade point average the first year receives up to $1,300 the second year.
SMART grants provide up to $4,000 to third- and fourth-year students who meet the above criteria and are pursuing degrees in physical, life, or computer science; math, technology, or engineering (as determined by the education secretary); or a foreign language deemed critical to national security. Students need to maintain a 3.0 average in their major.