Students winners in revised U.S. loan program

The idea of politicians tinkering with billions of dollars in the student-loan program can make anyone a bit wary.

But this time they got it right, with students coming out the winner in legislation passed recently by Congress and to be signed by the president.

The law, the College Cost Reduction Act of 2007, will cut nearly $21 billion in government subsidies to lenders over the next five years. Almost all the money will be plowed back into grants for the poorest students, lower interest rates and loan forgiveness for those in careers that society values but underpays.

"They are putting the money where it should be," says Sarah Bauder, director of financial aid for the University of Maryland at College Park. "We are helping the high-need students finance their education."

Lenders are unhappy and say the cuts will backfire.

Kevin Bruns, executive director of America's Student Loan Providers, predicts less service, rising defaults and lenders dropping out of the loan program.

Some lenders will start eliminating borrower discounts next month when the subsidy cuts kick in, making loans more expensive for students, he says.

"There is a perception that the lender is raking in profits and can afford it," Bruns says. "There is no way you can have a strong private sector-based program if lenders aren't able to earn a reasonable return."

Some of what lenders predict might come true.

Small lenders might leave the student-loan business. But more than 3,000 make loans, and that's more than enough. Major players aren't expected to quit the market.

Lenders also might drop some discounts, but the value of those discounts was always mixed.

"If you qualified for them, they were valuable," says Mark Kantrowitz, publisher of FinAid.com, an online provider of financial-aid information. "But few people qualified for them."

Lenders, for example, might offer a discount after a borrower has made continuous on-time payments for three or four years. But many borrowers miss a payment and don't get the discount.

If it turns out the subsidy cuts are too deep and the federal loan program suffers, Congress can restore funding. But from what it looks like now, students will reap significant benefits without a tax increase for the rest of us.

Here's what borrowers can look forward to:

• Expanded Pell Grants. The biggest chunk of the money will go toward increasing the size of Pell Grants awarded to lower-income students. This is money students don't have to pay back.

The maximum grant, currently $4,310, will increase to $4,800 next year. The amount periodically grows until the maximum reaches $5,400 in 2012.

• Lower interest rates. The fixed rate on subsidized Stafford loans for undergraduates, now 6.8 percent, will be cut in half over the next four years. Starting next year, the rate on new loans will be 6 percent, with further cuts to be phased in each year. By July 2011, the rate will be 3.4 percent.

Kantrowitz figures the typical student with $10,000 in subsidized loans will save $1,000 in interest over the life of the loans. Subsidized loans are those where the government pays the interest while students are in school.

The fixed rate will revert to 6.8 percent on new loans in 2012 unless Congress extends the reduction.

• Grants for teachers. Beginning next year, people studying to be teachers might qualify for grants worth as much as $4,000 a year for a total of $16,000.

The grants come with strings. Recipients will have to teach a subject in high demand, such as math, science, special education or a foreign language. They must commit to teach at least four years in an area where there is a shortage of educators.

Recipients get eight years after graduation to fulfill their obligation. If they don't, the grants convert to unsubsidized student loans, and they will owe not only the principal but accrued interest.

"It's a strong incentive," Kantrowitz says, to make sure people keep their end of the bargain.

• Lenient repayment plan. For graduates struggling to keep up with loan payments, there will be a new repayment option beginning in July 2009.

The plan essentially limits payments to no more than 15 percent of discretionary income. This can lower monthly payments significantly for students with low incomes and high debt, Kantrowitz says.

With lower payments, borrowers get more time to repay. After 25 years of making payments, any unpaid balance is forgiven.

• Loan forgiveness. Graduate and undergraduate loans can be forgiven even faster — after 10 years — for people in a wide range of public-service careers. These include police, social workers, school librarians, government employees, members of the military, public defenders and prosecutors.

"We are hoping this will help graduates follow their passion, which is better for our society and our economy," says Robert Shireman, executive director of Project on Student Debt in California. "People can become teachers and social workers. That's good for all of us."

Forgiveness, of course, will benefit people in the income-based repayment plan who are taking longer than the standard 10 years to repay loans. To be eligible, a loan must be a federal direct loan, meaning it came directly from Uncle Sam and not through a private lender. Students whose schools weren't in the direct-lending program still can be eligible for forgiveness by consolidating their loans through the direct-lending program. Even those who already consolidated can do so again to take advantage of the forgiveness program, Kantrowitz says.

They also must make 120 monthly payments on loans while in public service. The clock starts ticking next month, so payments made before then won't count, Kantrowitz says.

One potential outcome of the legislation is lenders might increase marketing of private loans profitable to them.

But if students must borrow, they first should choose a federal loan, the best deal around.