Big Changes Ahead in Student Lending Programs

The private sector will service loans, with the government in charge of lending to the lucrative student market.

By Renuka Rayasam, Associate Editor, The Kiplinger Letter

July 23, 2009

Private lenders are losing the battle over student loans. By this time next summer, they will be cut out of the lucrative student lending market, with a handful of them relegated to the role of simply servicing loans made by Uncle Sam. On July 21, the House Committee on Education and Labor began marking up a bill, introduced by Rep. George Miller (D-CA), that seeks to eliminate government subsidized private student lending and replace it with direct loans to students through the Department of Education.

“This is the biggest change in federal loans for higher education since 1965 when the original program was created,” says Terry Hartle, senior vice president at the American Council on Education.

Sallie Mae was one of four companies awarded a loan servicing contract by the Department of Education. NelNet, American Education Services/PHEAA and Great Lakes Education Loan Services Inc. were the others. Even with the servicing contract, the bill means “we would be about half of our size,” says Martha Holler, spokesperson for Sallie Mae.

Look for Congress to pass the direct lending plan sometime this fall. The Congressional Budget Office estimates that it will save about $87 billion over the next 10 years. “Among other things, the savings will be used to significantly boost Pell Grant scholarships [ need-based grants given to low income students] to keep interest rates low on need-based federal student loans for years to come, to simplify the [Free Application for Federal Student Aid] form, [and] to invest in strengthening community colleges,” said Rachel Racusen, deputy communications director of the House Education and Labor Committee, in an e-mail.

Lenders worry that the savings will be used to plug other budget gaps rather than to fund additional higher education financing. Already, Congress’ plan dramatically cuts the level of Pell Grant entitlements envisioned in the Obama administration’s proposal to address the issue of who should be in the student lending market. Under that plan, less than half the savings would have gone toward that grant measure, with the other money going toward other purposes.

Meanwhile, many lenders argue that with only direct lending, students get less in the way of services. “We offer the ability to maintain the diversity needed to keep competition up and pressure on other lenders,” says Christopher Chapman, CEO of Access Group, a Wilmington, Del.- based nonprofit student lender. “We also provide the value-added services,” such as financial education.

Banks have their own turf to protect. The legislation means not only lost profits for banks now, but also a tougher time courting young borrowers in the future. In the past, college loans provided lenders easy entrée to establish a relationship with a future customer.

For schools, the legislation translates into a major overhaul of their lending programs. Only about a quarter of eligible schools participate in direct government lending. “To implement the proposal, about 4,500 schools would have to convert lending systems,” says Holler. “It’s not like putting a different disk in their PC; the whole system has to be reworked.”

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