New Rules Streamline Student Loans, Eliminate Some Pitfalls

For more than four decades, students have borrowed money from Uncle Sam to pay for college. That tradition continues this year, but with a twist: Starting July 1, all students who take out federal student loans will borrow directly from the federal government, instead of through a private lender.

The change, included in the health care overhaul bill that cleared Congress last week, has caused considerable turmoil in the banking industry, which stands to lose billions of dollars in federal subsidies. But for borrowers, the change will be much less drastic. Interest rates for federal student loans won’t change, nor will the limits on how much you can borrow. And Uncle Sam is no pushover: If you fail to repay your loans after you graduate, you’ll still face stiff penalties.

President Obama is expected to sign the bill today. How the law will affect borrowers:

Less confusion. In the past, the type of federal student loan you received was determined by the school you attended. If you attended a school that participated in the Direct Loan program, you borrowed directly from the government; if your school participated in the Federal Family Education Loan program, you borrowed from a private lender. Starting July 1, all schools will provide loans through the Direct Loan program. "One of the advantages of the Direct Loan program is that it has a smoother origination process," says Mark Kantrowitz, publisher of, a financial aid website. "The schools determine how much you’re eligible for; they send you the master promissory note; you sign it; and you’re done."

While the FFEL program gave borrowers a choice of lenders, it also led some borrowers to make costly mistakes, says Lauren Asher, president of the Project on Student Debt. Many FFEL lenders offered both federally guaranteed Stafford loans and non-federal private loans, she says. That led some borrowers to consolidate their private and Stafford loans, which caused them to lose some of the benefits of their federal student loans, such as more flexible repayment terms, she says. Others took out private loans before maxing out on their federal student loans, which typically offer lower interest rates than private loans.

Lower interest rates for parent borrowers and graduate students. Because there are annual limits on Stafford loans, many parents take out a federally guaranteed Parent Loan for Undergraduate Students (PLUS) to pay for costs not covered by financial aid and Stafford loans. The interest rate for PLUS loans obtained through the Direct Loan program is 7.9%, vs. 8.5% for PLUS loans provided by private lenders, Kantrowitz says.

In addition, parents will have an easier time qualifying for a PLUS loan through the Direct Loan program, Kantrowitz says.

PLUS lenders are allowed to reject applicants who have an adverse item on their credit history, such as a foreclosure or bankruptcy. But a FinAid analysis found that the Direct Loan program has a higher approval rate for PLUS loan applicants than private lenders, Kantrowitz says.
Graduate students could also benefit from the lower rate. Since 2006, they’ve been eligible to take out PLUS loans under the same terms as parent borrowers.

Lower payments for low-income graduates. Starting in 2014, borrowers who are experiencing financial difficulties can apply to have their loan payments capped at 10% of discretionary income, says Patrick Kandianis, co-founder of SimpleTuition, a student loan comparison website. That will result in lower monthly payments than required under the current income-based repayment program, which caps payments at 15% of discretionary income. The lower cap will only be available to borrowers who take out loans after July 1, 2014.

In addition, borrowers in the income-based repayment program who make payments for 20 years will be eligible to have the balance of their loan forgiven. Currently, graduates in the program are eligible for loan forgiveness after 25 years.

Expanded Pell Grants. The federal Pell grant program provides direct federal aid to millions of low-income students, reducing the amount they need to borrow. The legislation increases the maximum Pell grant for the 2010-11 academic year to $5,550, up from $5,350 for 2009-10. The maximum Pell grant will remain at that level through 2012-13; for the next five years, it will be indexed to inflation. Without the law, the maximum Pell grant would have declined.


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