Students Face Changes in U.S. Aid Programs

Big changes are in the offing for college financial aid programs, thanks to the Deficit Reduction Omnibus Reconciliation Act, which is expected to get final approval in Congress next month.

The good news for students and graduates is that the act would create new grants for needy borrowers, give breaks to military personnel with outstanding loans and raise loan limits.

But the bulk of the changes would cost students money in the long run, said Mark Brenner, vice chairman and executive officer of College Loan Corp., a San Diego-based company that makes student loans. The law would do away with variable interest rates on new student loans, hike rates for parent borrowers and bar so-called consolidation loans for those still in school.

Some experts suggest that students -- and their parents -- lock in today’s lower rates before July, when both the bill and regularly scheduled interest rate changes are expected to go into effect.

“If you have a choice to borrow now or borrow later, borrow now and use your cash later,” Brenner said.

What changes would the new law bring, and what can students do to mitigate the effect? Here are a few answers.

Question: How would the proposed law affect student loan interest rates?

Answer: Student loans currently have variable rates that change once annually, in July, based on 91-day Treasury bill rates set at the last auction in May. Today’s rates are 4.7% for those still in school and 5.375% for those in repayment. The rate on Parent Loans for Undergraduate Students, also known as PLUS loans, is 6.1%.

Under the new law, newly issued student loans would carry a fixed interest rate of 6.8%. That rate would be the same, no matter whether the student is in school or out. Loans made to parents would carry a fixed 8.5% rate.

On the bright side, loan origination fees that can be as high as 4% of the loan amount under current law would be gradually reduced under the proposed law and eliminated by 2011.

Q: Does that mean that the interest rate on my existing loans will jump to 6.8% if the law goes into effect?

A: No. Student loans are governed by the rules that were in effect when the loan was taken out. Loans disbursed before July 1 will remain under the old variable-rate formula; loans taken out after that would be fixed-rate.

But given rising interest rates, the cost of variable-rate loans is likely to jump in July. Based on recent T-bill rates, student loans that are in repayment would jump to about 6.5%, said Bob Murray, spokesman for Indianapolis-based USA Funds, which guarantees student loans.

Q: Can I lock in today’s rates?

A: Yes. Current rules allow borrowers to exchange their variable-rate student loans for fixed-rate consolidation loans. Consolidation loan rates are set at the weighted average rate of all loans consolidated, rounded up to the next one-eighth of a percentage point. That means that a 4.7% variable-rate loan would be consolidated into a 4.75% fixed-rate consolidation loan.

Q: What’s the downside of a consolidation loan?

A: There are two significant drawbacks for students -- and one minor drawback for graduates.

The most significant effects are on students with subsidized loans. With a subsidized loan, the government pays the interest while the student is in school. The subsidy, however, is lost when the loan is traded for a consolidation loan, said Cheryl Watson, communications director for student lender Nelnet Inc., based in Lincoln, Neb. In most circumstances, students with subsidized loans would not benefit from consolidation.

The second drawback: Securing a consolidation loan technically puts the loan into repayment. If the student is in school, he or she can continue to delay repayment by filling out forms for an in-school deferment. But the person needs to remain in school at least half-time to maintain that payment hiatus.

For parents and former students , the only drawback is that the rate becomes fixed, so if rates drop in the future, the student wouldn’t get the benefit of the lower future rate.

Q: Does the proposed law make any changes to consolidation loans?

A: The new law would bar students after July 1 from consolidating their loans while still in school.

Q: How much can students borrow through the student loan program?

A: It depends on their year of study. Freshmen can borrow a maximum of $2,625, while sophomores can borrow as much as $3,500. Juniors and seniors can borrow $5,500 a year.

The proposed law would boost loan limits to $3,500 for freshmen and $4,500 for sophomores. The limit for juniors and seniors would stay the same. The law also would give graduate students access to PLUS loans, which have no set maximums. (PLUS loans are available for the full cost of college, minus other aid received.)

Q: What grants would be available under the new law?

A: There would be two new merit-based grants for students who qualify for federal Pell Grants and who complete demanding high school courses. These grants could amount to $750 for freshmen and $1,300 for sophomores. The law also would create grants for juniors and seniors studying science, math, technology, engineering or a foreign language deemed critical to national security, Murray said. These so-called SMART grants could pay as much as $4,000 a year per student.

Q: How would the law affect members of the military?

A: It would give them the ability to defer repayment of their student loans for as long as three years while they serve on active duty or in the National Guard during wartime.

Q: How likely is this law to pass?

A: It’s nearly certain. It has already been approved by the Senate -- and a very similar version was approved by the House. Overall, the bill is a cost-saver, shaving $40 billion from the federal budget.

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Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For previous columns, visit latimes.com/kristof.

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(BEGIN TEXT OF INFOBOX)

Juggling student debt

The budget bill could boost the cost of student borrowing by making student loans fixed-rate. Currently, students pay variable rates of 5.3% if they’ve graduated and 4.7% while in school*. As of July 1, the new rate will be 6.8%. Here’s a look at the cost of that difference over 10 years:

Payment and lifetime cost on a loan at different interest rates

*--* Loan amount At 4.7% At 5.3% At 6.8% $20,000 Monthly payment $209 $215 $230 Total cost $25,105 $25,809 $27,619 $60,000 Monthly payment $628 $645 $690 Total cost $75,316 $77,427 $82,858

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*While today’s rates are variable, they can be locked in with a consolidation loan.

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Source: Bloomberg News