Late in March, a task force of 17 NASFAA members forwarded an initial list of 61 recommendations for changes to the Higher Education Act in the upcoming Reauthorization to the NASFAA Board of Directors. The Board accepted most of those recommendations, although it requested that some be further developed.
This is the second in a series of articles, and the second of two on the Direct Loan Program, that highlight those recommendations. NASFAA encourages members to suggest additional areas where legislative change is needed in the Direct Loan Program. To do so, you may comment publicly below or send your concerns privately to email@example.com. For comprehensive coverage of all reauthorization topics, please refer to NASFAA’s HEA Reauthorization Web Center.
Elimination of Loan Fees
NASFAA’s Reauthorization Task Force (RTF) recommends that the loan fee currently charged to students be eliminated. This recommendation was also put forward by the NASFAA Indebtedness Task Force (ITF).
Loan fees were introduced to help offset loan subsidies in the FFEL Program. The origination fee was intended to be temporary when it was imposed on student borrowers in the early 1980s as a budget device, but is essentially a tax on students collected by withholding a portion of the student’s proceeds, but requiring repayment of the full loan amount before deduction of fees.
Loan fees also mask the borrower’s true loan cost and effective interest rate. After taking into account loan fees, the annual percentage rate on federal loans is higher than the government advertised interest rates.
The RTF believes that need-based borrower subsidies should be continued during in-school, grace, and deferment periods. RTF also recommends lifting the 150% limit on the interest subsidy.
It should be noted that the ITF recommended rethinking the Direct Loan subsidy structure to explore the efficacy of front-end subsidies and whether there are better ways to target resources currently invested in front-end subsidies. One such alternative recommended by the ITF is a back-end subsidy that utilizes automatic income-based repayment. This debate between front-end and back-end subsidies, which seem to be viewed as mutually exclusive due to budgetary constraints, has received much attention and continues to do so.
Meanwhile, loan subsidies have been incrementally eroded as Congress looks for sources of funds both to support the Pell Grant Program and to help alleviate the general budget deficit. The RTF is concerned that needy students are caught between lost buying power of grants, which have not kept pace with inflation and rising costs, and loss of beneficial loan terms.
The RTF believes that a long-term fix to Direct Loan interest rates is needed. An instrument should be established that will measure a fair market value of interest rates for student loans and the cost to administer the program, which can have a shared risk for both the taxpayer and the student. This rate could be established on July 1st and carry forth for the terms of the loan (“variable-fixed”). The rate determined on any July 1 would apply to all loans made within the ensuing year until the next July 1 determination. When a borrower has multiple loans with different rates, the monthly repayment amount could be determined as a weighted repayment of the separate loans.
For Parent PLUS loans, the RTF recommends linking the interest rate to market rates, such as a Treasury bill (T-bill) rate plus an additional percentage that reflects the cost to the government of borrowing money and servicing the loans.
For Grad PLUS loans, the RTF would discount the interest rate slightly (i.e., add a smaller percentage to the T-bill rate) and establish a cap over which the interest rate may not go. The premise here is that profit should not be an objective of the student loan program, but graduate students have a larger personal gain at stake from their advanced education.
For Stafford loans, the RTF would discount the interest rate further and establish a lower cap over which the interest rate may not go, on the premise that the federal government should help finance undergraduate education, which results in a more significant societal gain, by making loans affordable. If subsidized loans continue to be authorized, subsidized loans should be made at a lower interest rate than unsubsidized loans as there is a demonstrated need component.
Finally, if market interest rates decrease by some specified amount from the rate at which a borrower’s loans were made, the program should allow refinancing, subject to a refinance fee. Refinancing would be separate from consolidation provisions.
The ITF has also made a similar recommendation concerning interest rates, though not as detailed as that of the RTF. RTF is in the process of reconciling the recommendations.
The RTF recommends that the loan consolidation program be maintained to allow borrowers with multiple loans to have a single holder and a single payment. Consolidation should also continue to be used to prevent defaults. The interest rate should remain the weighted average of the loans being consolidated, although a modest basis point increase could be applied to consolidation loans.
Refinancing options should be allowed as noted above, but be kept separate from consolidation, so that consolidation retains its original purposes.
Publication Date: 5/21/2013