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Congress Proposes Overhaul of Federal Student Loan and Grant Programs

Congress Proposes Overhaul of Federal Student Loan and Grant Programs

Mark Kantrowitz

July 20, 2009

The US House of Representatives is considering legislation to overhaul the federal education loan and grant programs. The Student Aid and Fiscal Responsibility Act of 2009, nicknamed SAFRA, will increase funding for federal student aid programs and simplify the Free Application for Federal Student Aid. These changes will implement several of President Obama’s campaign promises.

Switch to 100% Direct Lending

Starting on July 1, 2010, all new federal Stafford, PLUS and Consolidation loans will be originated through the Direct Loan program. Some lenders may still service some of the loans as government contractors, but otherwise will no longer be involved in the funding of federal education loans.

Aside from the source of funds, some of the main differences between the Direct Loan and FFEL programs include:

• Interest rates on the PLUS loan are lower in the Direct Loan program. The interest rate is 7.9% in the Direct Loan program, compared with 8.5% in the FFEL program.
PLUS loan approval rates are higher in the Direct Loan program.
• Public service loan forgiveness is available only in the Direct Loan program.
• The Direct Loan program provides more limited loan discounts. The Direct Loan program offers a 0.25% interest rate reduction for borrowers who sign up to have their monthly payments auto-debited from a bank account.
• The Direct Loan program has a smoother loan origination process. The loans in the Direct Loan program are awarded and originated by the college financial aid office using the same disbursement mechanism as with the Pell Grant program, yielding a smoother process and quicker disbursements.

The Congressional Budget Office (CBO) has estimated that switching to 100% Direct Lending will save the federal government $87 billion over ten years. While the actual savings are unlikely to be that high, there will still be substantial savings mostly due to the federal government’s ability to borrow money at a much lower cost than the private sector.

Expanded Pell Grant and Perkins Loan Programs

Congress will use the increased profits to fund several key improvements in federal student aid programs:

• $40 billion to increase the maximum Pell Grant to $5,550 in 2010-2011 and by the inflation rate plus 1% thereafter. This will increase the maximum Pell Grant to $6,900 by 2019-2020. While the funding per recipient will increase, the number of Pell Grant recipients will not increase since the eligibility cutoff will remain unchanged.
• Increase Perkins loan funding four-fold from $1.5 billion to $6 billion a year, thereby increasing the number of eligible borrowers and the number of colleges that can offer these low interest rate loans. The interest rate will remain fixed at 5% and undergraduate students can borrow up to $5,500 per year ($8,000 per year for graduate and professional students), but the loans will otherwise be identical to unsubsidized Stafford loans.
• $3 billion to establish a College Access and Completion Fund. The goal of this fund is to help students remain in college, increase the number of students graduating, make it easier for students at 2-year colleges to transfer to 4-year colleges, provide financial literacy training to students and help college graduates find jobs.
• $1.275 billion for Historically Black Colleges and Universities and Hispanic Serving Institutions.
• $9.5 billion for various community college initiatives.

The legislation also directs $10 billion in savings to reducing the federal deficit.

Simplification of Student Aid Application Forms

The legislation proposes to simplify the Free Application for Federal Student Aid (FAFSA) by eliminating all questions about assets and more than three-quarters of the questions about untaxed income and benefits. This will cut about a page from the six-page form. More importantly, removing the asset questions will mean that there will no longer be any penalties for saving for college.

Changes to Penalties for Drug-Related Offenses

Previously, students who were convicted of sale or possession of illegal drugs while enrolled in college would have their eligibility for federal student aid suspended or terminated. The SAFRA legislation drops the suspension for possession, but toughens the penalties for sale of controlled substances. A first offense will result in a two-year suspension of eligibility and a second offense will result in an indefinite suspension of eligibility.

Changes to the Subsidized Stafford Loan Program

The legislation also makes some changes to the subsidized Stafford loan program. The government pays the interest on subsidized Stafford loans while the student is in school and for six months after graduation. This is in contrast with the unsubsidized Stafford loan, where the interest is the borrower’s responsibility during the in-school and 6-month grace periods. The College Cost Reduction and Access Act of 2007 had previously reduced the interest rates on subsidized Stafford loans for undergraduate students. The interest rates on these loans are dropping to 3.4% by 2011-2012, but unfortunately will revert to 6.8% for new loans made on or after July 1, 2012. Congress is proposing to address this by replacing the 3.4% fixed interest rate with a variable interest rate equal to the 91-day T-Bill rate plus 2.5% and capped at 6.8% for new loans on or after that date. The interest rate on unsubsidized Stafford loans remains unchanged at 6.8%.

(The original version of HR 3221 proposed to end subsidized Stafford loans to graduate and professional students starting July 1, 2015. The Manager’s Amendment to HR 3221 struck this provison. The Manager’s Amendment also changed the variable interest rate from the 91-day T-Bill plus 2.3% to the 91-day T-Bill plus 2.5%.)


For additional information and technical details, as well as the full text of the 181-page legislation, please see Student Aid and Fiscal Responsibility Act of 2009 on the FinAid site.


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