At present, most loans are made by banks or other private lenders, administered by state or private guarantorsa and insured by the federal government. The Feds pay the banks and the guarantors for their services. If you default, the taxpayers typically cover 98 percent of the loss. So lenders earn their comfortable profits at small risk. Estimated cost to government this fiscal year: $6.3 billion.
The president’s new direct-lending program cuts out the middlemen. You get your loan directly from your school. which draws the money from a government-funded account. Repayments go to the Treasury. Private contractors administer the loans and handle collections. The government expects to make money on the program the same way the banks do – by borrowing at a low interest rate and lending to students at a higher one. The Feds also think they’ll pay less in administrative costs.
Fierce resistance to direct-lending, by the lenders and guarantors that now handle the business, almost snuffed the program at birth. With opponents in the ascendancy, the lobbysits are again in full cry. Controversy surrounds the question of how much money, if any, direct lending saves. Doubters say that the government wouldn’t know how to run a stocking, although schools already using the system say it works fine. There are successful federal programs, such as social security. The question is whether direct lending can be one of them and whether the administration will be given a chance to find out. What students need to know:
Of course. It’s the same loan, with the same borrowing terms, that other students get at banks. Fees were lowered in 1994 and loan amounts raised. Dependent undergraduates can borrow up to $23,000 for their education – one third more than was formerly allowed. If you show financial need (a complex formula, comparing gamily income with college costs) the government pays the loan interest while you’re in school. Otherwise, you owe the interest although your payments can be deferred.
Around half of all undergraduates borrow today; they graduated last year with an average debt of $10,500, according to Jerry Davis, director of research for Sallie Mae, a prime player in the private-loan market. Due to rising tuitions and increased loan availability, last year’s entering freshmen will probably graduate $13,600 in debt, Davis says – a 30 percent increase. Average payments will rise to $163 a month, from $126 today.
Probably so, in two major ways. You get the loan at your school, which saves you a couple of steps. Even late applicants can get paid before school starts, because their request doesn’t wind through the banks. The portion of student loans processed by the fall semester rose 35 percent at Colorado State University, reports Kay Jacks, head of financial aid – thanks largely to direct lending. If a student’s eligibility changes, the loan amount can be adjusted overnight. By contrast, getting a change through a private lender can be a bureaucratic headache, Jacks says. Direct loans also save the schools from coping with each lender’s separate forms.
Ironically, free-market competition wasn’t fixing these problems. But government competition has been a “wake-up-call,” says Susan Conner of the USA Group, which guarantees and services student loans. USA now delivers loans faster and can give schools a speedy update on an application’s progress, she says. Eighteen institutions with major loan programs – including Citibank, Chemical Banks and Bank of America – plan to create a common electronic lending system. One reason that Duke University isn’t offering direct loans, says James Belvin Jr., head of financial aid, is that private lenders are falling all over themselves to improve.
The vast majority of students pay within the normal 10-year term. But as loans mount, longer terms may become more common. Direct lending offers an “income contingent” repayment plan that pegs your payments to the money you earn and how many dependents you have. Typically, you’ll owe from 4 to 15 percent of your adjusted gross income.
Private lenders will compete in this arena, too – the first being Sallie Mae, which will announce an income-sensitive plan this week. But there’s a downside. Stretching out payments always increases your interest costs. In the government plan, your payment may not even cover all the interest due. Any missing amounts will be added to your loan, increasing your debt by as much as 10 percent. So use this program only as an alternative to default.
You can refinance them through the direct-loan program or its private competitors. The U.S. Education Department hopes to take over large numbers of current loans, and says that will save the government money. But private lenders are screaming and the new program is unproven. Congress may dig in its heels here.
One thought is to quit giving government-backed loans – direct or otherwise – to high income families. For the past two years, student loans have been open to everyone, regardless of wealth. When interest rates are low, the well-to-do pay their own way. But no student is charged more than 8.25 percent. When student-loan rates go higher, as they may do in July, taxpayers absorb the extra cost. If Goodling’s prime concern is the federal budget, he ought to be looking at this issue, too.
