Overhaul to the Federal Student Loan Program

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Overhaul to the Federal Student Loan Program

Published: April 4, 2010

With all of America debating health care reform, you may be surprised to learn that the recently passed health care legislation - the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010 - includes several provisions related to education. The most noteworthy of these provisions involve the issuance of Pell Grants, the distribution of federal student loans, and an income based repayment program for federal student loans.

The new legislation, which rewrites an almost five-decade-old law on federally issued student loans, was piggybacked onto the expedited health care bill that passed last month. Under the new law, issuance of student loans will be transferred from the private sector to the government, thereby allowing students to borrow directly from Uncle Sam. Under the plan, it will now be easier for students to repay federal loans without incurring the interest and fees tacked on to standard loans by private entities.

Pell Grants

The Pell Grant is the federal government's largest financial aid grant program. It is available to undergraduate students who demonstrate exceptional financial need. Students from families who earn less than $45,000 per year are eligible while graduate students are not.

In the current 2009-2010 academic year, which runs from July 1, 2009 through June 30, 2010, the maximum Pell Grant award is $5,350. In 2010-2011, it is scheduled to increase to $5,550 and will remain at that level for two years. The new legislation provides for automatic annual inflation-adjusted increases beginning in 2013. Thereafter, the Pell Grant will increase by the rate of inflation (via the consumer price index) in each of the next five years, reaching approximately $5,900 in 2019-2020.

The distribution of federal student loans

There are currently two ways of obtaining a federal student loan - borrow directly from the federal government under the William D. Ford Federal Direct Loan ("Direct Loan") program or borrow from a private lender who participates in the Federal Family Education Loan (FFEL) program. The Direct Loan program has been in existence since 1994 while the FFEL program has been around since 1965. Private lenders in the FFEL program are encouraged to loan money as they receive government subsidies earmarked toward student loans.

Starting July 1, 2010, all federal student loans will be made directly to borrowers from the government under the Direct Loan program. Under the new legislation, private lenders will no longer receive government subsidies to make federal student loans, thus eliminating the FFEL program.

Students should not notice a difference with this change. The new system is being promoted as simpler and easier since borrowers will not have to "shop around" for a private lender to obtain a federal student loan.

Parents who wish to obtain a federal PLUS Loan might find themselves in a better position as the interest rate under the new program is capped at 7.9 percent, compared to the current rate obtained through the FFEL program, which is capped at 8.5 percent.

Income based repayment

On July 1, 2009, the government's new Income Based Repayment (IBR) program went into effect. The IBR program was created to help college graduates manage an increasingly large student loan obligation. Under the program, a borrower's monthly student loan payment is calculated based on income and family size. A borrower is allowed to pay 15 percent of their discretionary income to student loan payments, with any remaining debt forgiven after 25 years. The program is open to graduates with a federal Stafford Loan, Graduate PLUS Loan, or Consolidation Loan made under either the Direct Loan program or the FFEL program.

Under the new legislation, borrowers who take out new federal student loans after July 1, 2014, will pay 10 percent of their discretionary income to student loan payments, with any remaining debt forgiven after 20 years.

While the new system is intended to provide approximately $61 billion in relief to the Pell Grant program, it will also remove approximately $70 billion from private sector lending. This is a huge deficit for the banking industry - an industry that is attempting to recover from the worst recession since the Great Depression.

William E. Lewis Jr., is a credit repair expert with Credit Restoration Consultants and host of "The Credit Report with Bill Lewis" on AM 1470 WWNN, a daily forum for business and financial news, politics, economic trends, and cutting edge issues.