Q&A; : Student Loan System in for Change

Federal lawmakers are about to make drastic changes in the student loan program, in the wake of a scathing government report saying conflicts of interest in the current system may be costing the government billions of dollars.

The overhaul, expected to save both the government and students time and money, would expand and make permanent a “direct loan” pilot program approved last year. The pilot program, scheduled to go into effect in 1994, would replace many of the bank loans with loans from schools and the federal government.

The idea behind direct lending is that it could save the government a bundle by cutting out the middle man--in this case, banks, which currently are guaranteed a 3.1% return on the student loan business. Not surprisingly, bankers and the Student Loan Marketing Assn., or Sallie Mae--which pools, packages and sells bank-generated student loans as interest-bearing securities--are fighting the proposed changes.

Both the House and Senate have prepared detailed bills that are similar in many respects. President Clinton also supports the proposals. As a result, many experts expect that student loan reforms will be passed into law this summer.

Here are some answers to questions about what direct lending for college would mean to parents and students:

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Q: What’s wrong with the current system of student loans, provided through banks and other private lenders?

A: The recent Department of Education report didn’t charge any one lender with wrongdoing, but said current procedures invite fraud because private student loan companies are compensated lavishly for collecting on delinquent loans and stingily when payments are made on time.

That gives the companies an incentive to encourage late paying, and could be one of the reasons that student loan default rates have remained so high, agency officials said.

Q: What’s the government proposing?

A: The House and Senate bills differ a bit, but both would phase in direct loans that are backed by the government rather than banks. The House version of the overhaul would phase out bank loans completely by 1998. The Senate version would split the business evenly between banks and the government in 1998, but would impose additional restrictions on bank lenders to make bank loans and direct loans comparable.

Both the House and Senate versions would reduce up-front fees and provide additional repayment plans for students.

Q: How would direct loans differ from bank loans?

A: There are both administrative and financial differences. Currently, when you fill out a financial aid application, your aid eligibility statement is sent directly to the colleges of your choice. If you are eligible to receive Stafford, PLUS or SLS loans--the most widely used loan programs--your college’s financial aid counselor will direct you to a private lender that can provide them. But the bank requires a separate loan application, promissory notes, etc.

Direct loans would be handled through the college as part of the financial aid process. Many experts believe this change would at least eliminate the loan application process.

Q: What about cost?

A: Both the House and Senate plans would drastically cut the up-front fees students pay when they take out one of these loans. Currently, banks can withhold up to 8% of the loan amount for origination fees and insurance premiums. In other words, you borrow $2,500 but the bank gives you only $2,300 and deducts $200 in fees. Again, the two bills differ slightly, but both essentially propose to cut the fees in half.

The Senate bill also anticipates cutting interest rates on most student loans by roughly 1 percentage point. (Rates now vary between 5% and 11%, depending on the type of loan.)

Q: How would payment plans change?

A: There would be a new payment option for graduates who go into public service, teaching or certain other relatively low-paying fields. This option would limit your total loan payments to a set percentage of your income. If, by sticking to that percentage, you are unable to pay off the loan within a reasonable period, the legislation may provide for some debt forgiveness. This detail has yet to be worked out, but congressional staff members say the lawmakers want to make sure you are done paying off student loans before you start collecting Social Security.

Q: Would students be given a choice? Could I request a direct loan when offered a bank loan?

A: No. Colleges would offer one or the other. The only way to get a direct loan, if your college doesn’t offer it, is to switch to a school that does. And vice versa.

Q: Which colleges will offer direct loans?

A: That is not yet clear. The Department of Education is in the process of soliciting volunteers for the first-year program, which is expected to encompass just 4% of the student loan market. So far, the program is all voluntary. Schools can join in or opt out, but if there aren’t enough volunteers, the Department of Education can conscript the colleges it wants as participants.

If direct lending will affect your choice of a college, call the school’s financial aid office and ask if the school is attempting to get into the program.

Q: What happens if I already have student loans with a private lender?

A: Already-issued loans are not affected; however, there is a chance that you would not be offered direct loans in future years. Some colleges have suggested that the program be made flexible enough to allow them to offer direct loans to incoming freshmen only. Continuing students, who already have loans, would stick with bank lenders. Presumably, that would reduce the confusion for students and financial aid counselors.

Q: When would direct loans be available?

A: Starting in the 1994-95 school year.

Q: Would all types of student loans be affected?

A: No. Perkins loans, the least expensive federal student loan program, are already administered through colleges. The changes would affect only Stafford, SLS and PLUS loans.