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Congress Passes Legislation Ending the Federally-Guaranteed Student Loan Program

Congress Passes Legislation Ending the Federally-Guaranteed Student Loan Program

Mark Kantrowitz

September 22, 2009

The US House of Representatives passed the Student Aid and Fiscal Responsibility Act of 2009 (SAFRA) on September 17, 2009 by a party-line vote of 253 to 171.

This legislation eliminates the federally-guaranteed student loan program and replaces it with 100% direct lending from the federal government. SAFRA uses the savings to fund an increase in the Pell Grant program among other initiatives. The US Senate is expected to consider its own version of the legislation within a few weeks.

The Congressional Budget Office (CBO) estimated that ending the origination of federal education loans by banks and other financial institutions would save the federal government $87 billion over the next ten years.

The education lenders countered with their own proposal, but the CBO scored it as saving $13 billion less. The Obama administration argues that the Direct Loan program saves the government money by eliminating the middleman. However, much of the savings comes from the federal government’s lower cost of funds.

From a practical perspective, most students will not notice much of a difference between the Direct Loan and federally-guaranteed student loan programs. Money is fungible — it’s still green whether it comes from a bank or from the US Department of Education.

The Direct Loan program has a lower interest rate on the PLUS loan program (7.9% versus 8.5%) due to a legislative drafting error that was never corrected. PLUS loan approval rates are also higher in the Direct Loan program. Customer service is a bit better during the loan origination process in the Direct Loan program, but a bit worse during repayment.

However, the US Department of Education has awarded contracts to four of the largest education lenders to service loans in the Direct Loan program. The SAFRA legislation has no impact on existing student loans or borrowers who have already graduated.

About half of the savings will be used to index the maximum Pell Grant to the inflation rate plus 1%. It would increase to $5,550 in 2010-2011 and likely reach $6,900 by 2019-2020. However, it does not turn the Pell Grant into a true entitlement program. Congress could still cut Pell Grant funding during the annual budget appropriations process as it did in 2008.

The legislation also eliminates all of the asset questions and many of the untaxed income questions on the Free Application for Federal Student Aid (FAFSA), cutting about a page from the six-page form. This will eliminate any penalty for savings in the federal need analysis formula, so there will no longer be any disincentive to saving for college.

SAFRA includes several provisions relating to student loans. The interest rate on subsidized Stafford loans for undergraduate students will switch to a variable rate capped at 6.8% starting on July 1, 2012. Otherwise the interest rate would have increased from 3.4% to 6.8% on that date, a big jump.

Annual funding for the Perkins Loan program would increase four-fold from $1.5 billion to $6.0 billion a year. While the new Perkins loan would no longer have subsidized interest, the interest rate would remain at 5.0%. Students at many more colleges would become eligible for the Perkins loan.

The new College Access Challenge Grant program would be focused on increasing enrollment, persistence and completion rates. It would fund financial literacy programs and make it easier for students to transfer from 2-year colleges to 4-year colleges. There would also be a significant increase in funding for community colleges and minority institutions.


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