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Positive Changes Coming for College Loans

November 30, 2009 By Lauren Benditt, Higher Education Policy Associate

If you've been to college, it's likely that you have them. Nobody likes them.  They're confusing. They're annoying. They're a little scary. And they'll follow you until death (yes, even when you file for bankruptcy).  If you haven't already guessed, they're student loans and they're on the docket for reform.

Two types of federal government guaranteed loans are available to help finance educational expenses: Federal Stafford Loans are provided directly to students and PLUS loans do the same for parents of current students. Currently, two federal programs offer these loans. In the Federal Family Education Loan (FFEL) program, banks provide the loans to students with the loans guaranteed by the federal government, which allows the loans to be offered at low interest rates. In contrast, funds for the Ford Federal Direct Loan (Direct Loan) program come directly from the federal government. Since the passage of the Omnibus Budget Reconciliation Act of 1993, which created the Direct Loan program, higher education institutions have been able to decide whether to provide student loans through private lenders (FFEL), directly from the federal government (Direct Loan) or from both sources.

The Direct Loan Program was created with the intention of simplifying federal student loans. With the FFEL program, after filling out the FAFSA students must be prepared to develop transactional relationships with their lender(s), guarantee agency(ies) and school. The Direct Loan program simplifies this process so that students only need to worry about directing payments to the Department of Education and their school.

According to a 2005 Congressional Budget Office analysis, the Direct Loan program also incurs lower costs to the federal government than do FFEL loans. The analysis indicates that for every $1 in loans the government incurs budgetary costs of $0.15 for FFEL loans and budgetary savings of $0.02 on direct loans. Though these cost savings do not tell us anything about the quality of loan servicing, they do represent billions of dollars in government savings that can be used to fund other important projects and programs-infrastructure improvement and Pell Grants to help low-income students fund their postsecondary education.

As of 2005, the FFEL program still accounted for three quarters of the student loans originated in the United States and still accounts for around 90 percent of those originated in Minnesota, but the playing field is rapidly changing. In September, the U.S. House of Representatives passed legislation that would eliminate the FFEL program, leaving the federal government to originate all student loans.

The University of Minnesota system has long been a user of the Direct Loan program and will likely be largely unaffected by any potential changes.  However, in the 32-school MnSCU system, only seven schools are currently using the Direct Loan program, though system officials acknowledge that "several other colleges are considering or moving toward that [the Direct Loan program]" with the understanding that "the situation is changing quickly."

Some private colleges in Minnesota may also be among those to experience a change in the way they disburse their student loans if the FFEL program is eliminated. Carleton College in Northfield is one of the shrinking number of private colleges that is still using the FFEL program. A college financial aid officer has indicated that they are waiting on federal legislation to make the switch to direct lending. However, Carleton officials have also said that "if legislation [eliminating the FFEL program] does pass we will be prepared to switch to direct lending at that time."

Switching to direct lending will undoubtedly mean significant changes, both for the government and for many colleges and universities.  The benefits, though, are two-fold: the cost savings is an important first step in making the student loan system more efficient, and student loans are complex enough on their own without students having to worry about their administrative structure. Ultimately, the evidence suggests that maintaining the status quo with the two loan programs for the sake of stability is both wasteful and burdensome. Moving to the more streamlined Direct Loan program is an important step in developing a more cost-effective higher education system.


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