Friday, March 26, 2010

Student Loan Reform - What Does it Mean for Me?

The recently passed healthcare reform bill will not only bring historic changes to how healthcare is provided; it will also change the way students borrow to pay for college. That’s right. The Obama proposed student loan reform was a late addition to the reconciliation bill passed last Sunday by the House. So the passage of healthcare reform this week also brought sweeping changes to federal loan programs for higher education as well as steady increases in financial aid for families with the most significant needs. The major changes to student financial aid fall into 3 categories: increases to Pell grants, elimination of the bank-based student loan program, otherwise known as the Federal Family Education Loan program or FFELP, and a modification to the loan repayment plan that will make it easier for graduates with modest income to repay their education loans (there are additional changes, though these are the three that most directly impact financial assistance for students).

Increases in the maximum Pell grants which are available to students whose families demonstrate the most significant financial need (typically income less than $45,000) will now be tied to the Consumer Price Index (though the original proposal was higher at CPI + 1%). The maximum award for 2010-2011 is $5,550 and will stay constant through the following two years. The grant size is expected to reach $5,900 by 2019-2020, nearly $1,000 a year less than that projected under President Obama’s original proposal. While the final version has been applauded, it is not expected to keep up with increases in college tuition, room and board, if history is any guide. Assuming the rise in cost of attendance continues to outpace the rate of inflation, the changes to the Pell program will do little to make college more affordable for students in the Pell eligible income bracket.

The big change in the federal loan program is the discontinuation of the bank loan option for federal student loans. The bank-based option has been available to colleges and universities since 1965 and accounted for as much as 80% of the federal student loan market. The federal government pays fees to lenders, though assumes the risk if the loans default. The Obama administration has made elimination of the FFEL program a primary goal for student aid reform, projecting a 10 year savings of $61 billion that will be used largely to support the increase in Pell grants. After July 1st all colleges and universities that participate in the federal Stafford loan program will join the Direct Loan program, shifting the administrative management from lenders to the colleges themselves.

How does this change impact students and their families? There are really two ways that borrowers will be impacted. No longer will students at colleges that participate in the FFELP program need to find a bank lender. Instead, those who apply for federally guaranteed Stafford loans will deal directly with the colleges’ financial aid offices. Secondly, the interest rate on the PLUS loans, which parents can access to pay their children’s college costs, is 7.9% with the Direct Loan program, versus 8.5% for the erstwhile bank program. With interest accruing while the student is in school, the difference can become significant over four years.

Changes to the income-based repayment plan, which became effective last July, will further ease the burden on students once they begin to repay their school loans. The purpose of the plan is to make it easier for graduates with low incomes to stay current and potentially limit their loan obligations through debt forgiveness. The bill just approved will make the repayment option available to more borrowers by lowering the debt to income threshold from 15% to 10% of discretionary income. Additionally, loans still outstanding after 20 years (versus the current 25) will be forgiven. The one catch is that this provision will not go into effect until July 1, 2014 and will only benefit those who borrow after that date.

So who are the winners and losers with the student loan reform bill? Low income students are winners, as they are now assured federal grant money that will grow with inflation. Whether it is enough to keep them from losing ground against rising college costs is in question, though doubtful. Student borrowers under the federal loan program should probably be indifferent to whether they borrow from a bank or through their college. The modified income based repayment plan is without a doubt the best deal for college graduates, though high school seniors who will start college in the fall lose out since the changes don’t become effective until July 1, 2014, the year they graduate.

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