By now you’ve heard that the President signed the Deficit Reduction
Act ("DRA") that is projected to save taxpayers $12 billion by making student
loan funding more efficient for taxpayers. Will it? Does it? Which taxpayers?
takes up less than 1% of federal entitlement spending. Yet, the DRA is
projected to provide 1/3 of the $39.7 billion dollar deficit reduction goals
set by Congress. Yes, it will save some
taxpayers money. But it will cost students and their parents more money. It is
a bit like raising taxes on gasoline while claiming that the government is
reducing overall transportation costs.
Make no mistake; students should expect that the cost of
student borrowing will increase July 1, 2006 when most of the provisions kick
in. Assuming the Act stands as it is now, here is a snapshot of things to come:
- Some students will be able to borrow more for
school. For example PELL Grants students
will become eligible for more money in the form of SMART grants if the student
is studying physical, life and computer sciences, mathematics, technology,
engineering or certain foreign languages. The new grants are expected to provide
between $750 and $400 in additional funds for student borrowers. - The Act creates new grant programs.
- Interest rates on PLUS loans will go up
8.5%. That equates to something like an
increase of $620 in interest over the life of a ten year loan. - Rates on government-guaranteed loans will switch
from variable to fixed-rate loans on or after July 1, 2006. The current rate is
4.7% if a student is in school or 5.3% if the student is out of school and
repaying the loan. These rates will go up based on the May Treasury bill rates
as high as 6 to 6.5% respectively. The upside to this is that students will
have more predictable loan payments; the down side is that interest rates on Stafford loans will increase from 5.3% to 6.8%. - All
new loans disbursed on or after July 1, 2006 will have fixed rates and will be at higher interest rates than they are now. Fixed rates are good for students if the short-term interest rate continues to soar. If however, short terms rates fall, fixed rate loans will be expensive. Depending on how risk adverse you are, locking in rates by consolidating existing loans might be a good option for you. - Consolidation of existing loans will be curtailed. Students will not be permitted to consolidate spousal or "in-school" loans. And reconsolidation of FFELP and DL will not be permitted under the Act, unless A FFLEP borrower who is delinquent can submit an application for a DL consolidation for the purpose obtaining an in income contingent on repayment. There are some exceptions for FFELP borrowers who may be able to consolidate depending on the lender.
- Military personnel in active duty will be able to defer their loans for the period they are in active duty up to three years. They will pay a higher interest rate, but there are also more liberal deferment and cancellation provisions. The deferment provisions are open to military personnel who are on active duty and national guardsmen called up for service.
- Private lenders are a different story. The way it works now is that private lenders are guaranteed a set rate from the Federal government. If the amount students pay falls below that set rate the difference is made up by the Federal Government. If the rates are higher, the lenders reap the profits. The DRA changes this so that private lenders lose out on the higher difference. If students pay more than the fixed rate the overall the difference will funnel into the treasury. The Congressional Budget Office projects that this will translate into $12 billion in revenue by the year 2010.
- Origination fees will be phased out by the year 2010. At first this looks like a good deal for borrowers. But, the real impact is going to hinge on what lenders do. Many lenders have already been picking up the origination fees. Under the DRA the maximum origination fee that may be charged to a Stafford loan borrower will be reduced from 3% to 2% on new loans disbursed on or after July 1, 2006. As a result, many lenders will charge lower up-front loan fees than they do now. In addition to reducing the origination fee, the DRA requires that all student loan guaranty agencies collect and deposit a 1% Federal Default Fee into their federally-owned-reserve-funds. The idea is that the collection of this fee is supposed to help offset some of the federal costs of the student benefits in the DRA, including the elimination
of FFELP origination fees. Although most private lenders have not announced plans to increase the cost of loans, a betting person should expect it.
Okay, okay, even if the Act reduces the deficit budget will
really make it more efficient for students? Probably not. Many provisions will be effective this July,
while others will phase in over time. So until schools and lenders work out the
details of implementing the provisions of the DRA, students should expect some
confusion. And, then the DRA will have to survive the legal attacks against it.
The first lawsuit challenging the legality of the DRA, was
filed on last week in Alabama.
House Democrats and many constitutional law experts argue the DRA is not legal
because a clerical error caused the Senate and House to pass different bills.
The Constitution requires both chambers to pass identical legislation before
the president signs a bill into law. The lawsuit is expected to be the first of
many lawsuits challenging the legality of the bill. With so many groups
planning to challenge the legality of the legislation, it is likely that at
least one court will hear the case. If that happens, the law could be suspended
while the case is argued. That means
schools and lenders will be in a bit of limbo until the cases are decided.
there are a host of other bills now in committee that would make more changes
to the existing programs. For example under some of the pending bills in
Congress:
- Variable rates issued before July 1, 2006 will continue to adjust every year. That will mean that PLUS loans will not be as competitive as other financing options like a home equity loan. And borrowers will no longer be able to refinance PLUS loans if the rate drops. They can be consolidated into fixed-rate loans, but the rate on consolidation is the weighted average of the rates on the loans being consolidated. Now may be a good time to think about consolidating existing loans. However, if you look at the last 20 years it seems that students
are better off if they have variable rate loans but it is always a gamble.
- Stafford loan limits for first and second year college students will increase: Starting 7/1/2007 the proposed limit for freshmen will rise to $3,500; sophomores could borrow $4500; while Juniors and senior could borrow $5,500.
- Graduate and professional students will be able to apply for PLUS loans.
- Stafford loans origination fees will phase out fall to 2% and then ½ percentage point per year until 2010.
remain good law with many provisions taking effect this July. Make friends with the loan administrators at
your school to stay up to date on all the latest rates, and loan limits. And expect some confusion until schools and
regulators work through the details.
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