Direct federal loans–good for students, parents and taxpayers

• March 29, 2010
• 2 comments
• Posted in College, Latest Posts

Starting July 1, higher-ed students will get their federal Stafford loans directly from the government rather than from banks. About 50 percent of students do this already, through the federal Direct Loan program. Under a provision tucked into the Affordable Health Care Act, all students will soon be borrowing that way.

The change will save the government a ton of money (by one estimate, $61 billion over 10 years). Even better, from my point of view, the change makes it harder for banks to do what they do best—namely, mislead their trusting student borrowers.

For years, the government has been handing the banks free money by letting them originate federally insured Stafford student loans. The banks got a fat subsidy for every loan they made. If the student defaulted, the government picked up most of the loss. In short, the banks were on the dole and their favorite legislators kept them that way.

It gets worse. When students couldn’t borrow enough with Staffords to cover their college costs, they were steered immediately into the bank’s own private student and parent loans. These loans carry higher interest rates and, often, extra fees. The student or parent might qualify for a lower-rate federal PLUS loan, but that’s something the banks usually forget to mention. Low-cost state and college loans might have been available too.

Direct loans are made through college financial-aid offices. If you need more money than a Stafford allows, the aid office can help you find additional loans at the lowest cost. PLUS loans for parents usually fill the bill, at 7.9 percent interest (the same PLUS loans from banks cost more). Aid expert Mark Kantrowitz, of www.Finaid.com, says that, unless the family is wealthy, the student usually pays off the PLUS as well as his or her own Stafford loans. So getting a lower interest rate matters a lot.

There’s a hitch with PLUS loans. Parents have to pass a credit evaluation. You can’t get a loan if you’ve declared bankruptcy over the past five years, defaulted on a loan, gone through foreclosure, had your wages garnished, been hit with a tax lien or repossession, failed to pay previous student or parent loans, or are more than three month late in repaying a loan. The Great Recession did a lot of damage among middle-income parents, making many of them ineligible for the PLUS. You might need a private loan anyway, but at least your school will offer counseling along the way.

I used to write, “never take a private loan without first consulting your school’s financial aid office. Often it can find you loans at much better rates.” After July, I won’t have to write that any more. It will happen automatically. Another good rule for student is, don’t borrow more for your education than your expected first-year starting salary. If it looks as if you’ll have to borrow more, switch to a cheaper school.

I’ve heard angry tea-party shouts about how the government is “taking over student lending.” Staffords and PLUS’s have always been government loans–nothing new there. Without federal backing, most students couldn’t borrow much money at all, let alone borrow at the low rate of 4.5 percent that subsidized Staffords will charge for the 2010-2011 school year. (Higher-income students who don’t qualify for federal subsidies will pay 6.8 percent.)

So the government hasn’t taken over anything. It has simply stopped paying subsidies to banks for distributing the government’s own loans. They’re saving that money for the taxpayers and modestly increasing Pell grants for families with below-average incomes. What’s not to like?

Tags: Direct Loan progam, student loans

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