The What, Why and Effect of the Federal Student Loan Program Change
Many were surprised - me included - to find that the recently passed Health Care Reform Bill also contained legislation that made significant changes to the Federal Student Loan Program. And the healthcare uproar has carried over to the college funding program as well. So why was it even done, what is in it and what does it mean for my family?
What Are the Demands and How Are They Being Addressed?
Like any major overhaul legislation, Congress is trying to meet multiple demands with one piece of legislation. What are the driving forces behind this?
First, people are learning that college is America's new default educational requirement. The problem, from a public policy/society level, is how to best help the largest number gain a degree with the money available.
- More money will be directed to the neediest students via the Pell Grant Program. Pell Grants are federal grants for students that demonstrate financial need and do not have to be repaid if the student meets certain completion requirements. These grants will be increased starting in 2013-2014 for five years and the increase will be linked to the Consumer Price Index.
- Those institutions that typically admit students from needier households are receiving more support. More money is being directed to Community Colleges ($2 Billion) and historically African-American Institutions ($750 Million).
- Removing the Financial Services Industry and SallieMae from creating and servicing federally backed loans saves tens of billions in costs.
Second, this is actually a pre-emptive response to the moral hazard created by the government bailout of Fannie Mae and the housing industry. Sallie Mae is a fully privatized lender that began as a Government Sponsored Entity is 1972. It was created to serve a single purpose - facilitate student lending - and was finally fully spun off from the government in 2004. This is exactly the same scenario as the now-bailed Fannie Mae and Freddie Mac. Likewise, the default rate on student debt is rising significantly just as the default rate on mortgages.
- We've learned from the mortgage debacle what happens when banks are able to originate loans for which they have no final exposure; fees are kept and the risk is passed along to the taxpayer.
- The government has no real system to penalize the financial industry for originating loans that will ultimately default.
- The administration of a large portion of the federal student loan program will be passed along to the colleges themselves. The government does have a mechanism - the Cohort Default Rates - to penalize colleges and universities that do a poor job of assessing the credit risk of a prospective student.
- The government has effectively made the program administrators somebody with "skin in the game".
Third, legislators are hearing the complaints of burdensome student debt - debt that can't be discharged via bankruptcy in the worst case scenario.
- The interest rate on the PLUS loans from the federal government will drop from 8.5% to 7.9%.
- The maximum monthly repayment amount for these loans will drop from 15% of income to 10% of income.
- Loan amounts outstanding after twenty years will be forgiven, a decrease of five years from the previous forgiveness period of twenty-five years. I do not know the tax consequences of this loan forgiveness.
So What Does This Mean For Me?
Here's what I suspect will be the upshot of the changes, apart from the continuing shift of students to the community college model.
The federal loan money will still be there but the problem will be gaining access to it. Colleges and universities are not in the business of personal lending, which is what this really is. As they assume and learn the responsibilities, they'll err on the cautious side to protect themselves from the Cohort Default Rate mechanism. The result will be that students and families with marginal credit histories will be frozen out. The institutions will probably also ask harder questions than families are used to asking. Do your grades support the likelihood of success required to get a living-wage job? Are your plans defined enough to merit the money paid for the degree?
The funding will dry up and more students will shift to local colleges and community colleges. The timespan required to earn a degree will lengthen accordingly. And we are all in for a cultural shock.
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