Health care and education reconciliation act student loans

This article was originally published by the Council on Law in Higher Education to accompany a similarly titled presentation and may be cited as:

Mark Kantrowitz, Overview of Student Aid Changes in the Recent Reconciliation Legislation, Marketplace of Ideas, Council on Law in Higher Education, April 14, 2010.

The Health Care and Education Reconciliation Act of 2010 (HCERA, P.L. 111-152, 3/30/2010) made major changes in federal education loan programs. This article addresses some of the more common questions about this legislation.

Q. What are the most important changes to student aid programs enacted by HCERA?

A. Starting July 1, 2010, all new federal education loans, including Stafford, PLUS and Consolidation loans, will be made through the Direct Loan program. The Congressional Budget Office (CBO) scored the legislation in March 2010 as saving $68 billion over 10 academic years (11 fiscal years). This savings was used to justify a $40 billion increase in funding for the Pell Grant program, $21 billion in deficit reduction, and spending on several smaller programs.

Q. Is this legislation the same as the Student Aid and Fiscal Responsibility Act (SAFRA)?

A. The original version of SAFRA (HR 3221) passed the US House of Representatives on September 17, 2009 by a vote of 253 to 171. Passage in the Senate would normally require a 60 vote majority. However, a parliamentary option called "budget reconciliation" permits passage with only a simple majority of 51 votes. Action in the Senate was delayed in order to preserve the use of budget reconciliation as an option for passage of health care reform. The delays lead to a rescoring of the legislation, leading to $20 billion cut in the savings attributable to the mandatory switch to direct lending. That, in turn, forced Congress to drop several provisions from the SAFRA legislation to save money.

Q. Why was budget reconciliation necessary?

A. The US Senate did not have the 60 votes necessary to pass the legislation without budget reconciliation. Senators with lender facilities in their states were concerned about the potential job loss. The legislation ultimately passed the US Senate 56 to 43 and the US House of Representatives 220 to 207 on March 25, 2010.

Q. Why was the student loan bill paired with the health care reform legislation?

A. There can be only one reconciliation bill per budget cycle. The Senate leadership knew that they would probably need budget reconciliation to pass both bills. In addition, the savings from the student loan bill would help ensure that the combined bill reduced the deficit, a prerequisite for any budget reconciliation legislation. Finally, the student loan bill was very popular in the US House of Representatives, bring several votes to the combined measure.

Q. What provisions were dropped from the final version of SAFRA?

A. The major provisions that were dropped included the Perkins loan expansion and reengineering and the indexing of the maximum Pell Grant to 1% over the inflation rate. Funding for the College Access Challenge Grant program was cut from $3 billion to $750 million and the Community College funding was cut from $10 billion to $2 billion. Funding for elementary and secondary education was eliminated. Finally, the additional FAFSA simplification changes were dropped. These included replacement of the 6 asset questions with a net asset cap on eligibility for need-based federal student aid and the elimination of 12 of the untaxed income and benefits questions.

Q. Does passage of this legislation mean all colleges need to switch to Direct Lending now?

A. Yes. The legislation is final. If a college wants its students to have access to federal education loans starting July 1, 2010, the college needs to switch to the Direct Loan program now without delay. Switching to the Direct Loan program may involve changes to administrative software systems, staff training and student publications.

Q. Is technical assistance available to help a college switch to the Direct Loan program?

A. The HCERA legislation included funding for the US Department of Education to provide technical assistance to colleges who are switching to the Direct Loan program. US institutions who need help should call 1-800-848-0978 or email DLEnrollment_FSA@ed.gov. Foreign institutions should call 1-202-377-3168 or email FSA.Foreign.Schools.Team@ed.gov.

The National Direct Student Loan Coalition, a group of colleges already in the Direct Loan program, is also providing assistance. Visit www.directstudentloancoalition.org for more information.

Q. Does the switch to Direct Lending affect existing loans?

A. No. Existing FFELP loans will remain with the lenders unless the borrowers consolidate their loans into the Direct Loan program. All borrowers may consolidate into the Direct Loan program even if they have previously consolidated in the FFEL program.

Q. What are some of the key practical differences in the Direct Loan program from a borrower perspective?

A. The interest rate on the Direct Loan version of the PLUS loan (both Parent PLUS and Grad PLUS) is lower and the approval rate is higher. The PLUS loan has a 7.9% interest rate in the Direct Loan program, compared with the 8.5% interest rate in the FFEL program. The Stafford loan is essentially identical in both programs.

Student and parent borrowers in the Direct Loan program obtain their federal education loans from the college's financial aid office instead of having to find a lender. After the borrower signs the Master Promissory Note (MPN) the college will be able to pull down the loan funds directly from the US Department of Education. The Direct Loan program gives colleges more administrative responsibilities, but also gives them more control over disbursements.

Q. Why is the interest rate on the PLUS loan lower in the Direct Loan program?

A. The Higher Education Reconciliation Act of 2005 (HERA), enacted as part of the Deficit Reduction Act of 2005 (PL 109-171, 2/8/2006), increased the interest rate on the PLUS loan from 7.9% to 8.5% effective July 1, 2006. (The Stafford loan interest rate was scheduled to switch to a fixed rate of 6.8% and the PLUS loan interest rate to a fixed rate of 7.9% on July 1, 2006 by legislation enacted in 2002 (PL 107-139, 2/8/2002).) Due to a legislative drafting error, the increase were applied only to the FFEL version of the PLUS loan. The Direct Loan version of the PLUS loan remained at 7.9%.

Q. Why is the PLUS loan approval rate higher in the Direct Loan program? Don't both programs use the same adverse credit history criteria?

A. The eligibility requirements for the PLUS loan require borrowers to not have an adverse credit history. An adverse credit history is defined as having a current delinquency of 90 or more days on any debt or a five-year lookback for certain derogatory elements of the credit history, such as bankruptcy discharge, foreclosure, repossession, tax lien, wage garnishment or default determination. Some FFELP lenders have incorrectly used a five-year lookback for 90-day delinquencies, instead of just a current 90-day delinquency. This is not a violation of the regulations, as the regulations at 34 CFR 682.201(c)(2)(iii) permit lenders to adopt more stringent credit underwriting criteria. But it is an error that increases the denial rate significantly. Analysis of 2007-08 data from the National Postsecondary Student Aid Study shows a Parent PLUS loan denial rate of 42% in the FFEL program and 21% in the Direct Loan program.

Q. Will current borrowers benefit from the lower interest rate on the PLUS loan in the Direct Loan program?

A. The switch to the Direct Loan program affects only new loans. Existing PLUS loans in the FFEL program will be unchanged. Consolidating a FFELP PLUS loan into the Direct Loan program does not change the underlying interest rate on the loan.

Q. Who will be servicing the loans in the Direct Loan program?

A. The US Department of Education awarded servicing contracts to four FFELP lenders, who began servicing new Direct Loans in August 2009. These contractors are Sallie Mae, Nelnet, PHEAA and Great Lakes. Borrowers are assigned randomly to the servicers to permit an apples-to-apples comparison of servicing performance without regard to demographic differences among the borrowers. Servicing performance includes default aversion, and customer service surveys completed by borrowers and colleges. Servicing volume will be adjusted according to servicing performance. In addition, HCERA earmarked servicing contracts for up to 100,000 borrowers total in each state to certain non-profit state servicers.

Q. Borrowers could end up with three different types of loans each of which must be serviced separately: FFELP loans, FFELP loans sold to the US Department of Education through the ECASLA legislation, and Direct Loans. Does HCERA include any options to help borrowers simplify the repayment process?

A. Borrowers with loans in at least two of these programs may consolidate their loans while they are still in school from 7/1/2010 to 6/30/2011. The interest rate will be the weighted average of the interest rates on the loans being consolidated, without the usual rounding of the interest rate to the nearest 1/8th of a point.

Most borrowers should not use this provision as they will lose the remainder of the six month grace period on their loans. There is no real benefit to consolidating loans while they are in school, as the interest rates on federal education loans made since 7/1/2006 are already fixed. The financial benefit of avoiding the rounding up of the interest rates by 1/8th of a point is negligible. Many borrowers will need their six month grace period in the current difficult job market. Moreover, borrowers can simplify the repayment process by consolidating their loans after they enter repayment.

Q. How is the income-based repayment plan changing?

A. The HCERA legislation implements President Obama's proposal to improve the income-based repayment plan. It cuts the monthly payment by one-third from 15% of discretionary income to 10% of discretionary income. It also accelerates the forgiveness of the remaining loan balance from 25 years to 20 years. These changes are effective for new borrowers of new loans made on or after July 1, 2014.

Q. Is public service loan forgiveness changing?

A. No. Public service loan forgiveness will still forgive the remaining loan balance after 10 years of full-time employment in a public service job when the federal student loans are repaid in the Direct Loan program.

Q. Will current borrowers benefit from these changes?

A. No. The changes are not retroactive. Current borrowers will continue to use the current income-based repayment program, however, which is still a pretty good safety net for borrowers who are experiencing financial difficulty.

Q. Some people have called the HCERA legislation the "single largest investment in college aid ever", noting that it invests $36 billion over 10 years to increase the maximum Pell Grant. But you have called the increases in the maximum Pell Grant anemic. Who's right?

A. The American Recovery and Reinvestment Act of 2009, the stimulus bill, increased the maximum Pell Grant to $5,350 for the 2009-10 academic year. This was a one-time increase, valid only for one academic year. In addition, Congress underestimated the number of applicants who would qualify for the Pell Grant, leading to a funding shortfall. Most of the increase in funding for the Pell Grant program will be used to backfill the funding shortfall and to maintain the stimulus bill's increases in the Pell Grant more permanently. Unfortunately, this leaves very little money for increases in the Pell Grant beyond the $5,550 maximum grant for the 2010-11 academic year.

The maximum Pell Grant will remain flat at $5,550 from 2010-2011 through 2012-2013, then it will be indexed to the Consumer Price Index (CPI-U) inflation rate from 2013-2014 through 2017-2018, and then it will remain flat from 2018-2019 through 2019-2020. The projected maximum Pell Grant will be $5,975 in 2019-2020, only $425 more than the maximum Pell Grant in 2010-2011. This yields an average annualized increase of CPI-U minus 0.75%. Thus the increases in the maximum Pell Grant are anemic and will not keep pace with inflation. This falls short of President Obama's proposal for indexing the maximum Pell Grant to CPI-U plus 1%, as was passed by the US House of Representatives in September 2009. It also does not eliminate the feast/famine cycles that have lead to an unchanged maximum Pell Grant for years at a time, as happened for four years during the Bush administration.

Q. If Congress hadn't passed HCERA, would the maximum Pell Grant have been cut in half as some people have said?

A. If Congress hadn't passed HCERA or otherwise backfilled the Pell Grant funding shortfall, the maximum Pell Grant would have been cut severely in 2010-2011. The Pell Grant program is an academic year program that runs from July 1 to June 30. This spans two federal fiscal years, which run from October 1 to September 30. When appropriations for the Pell Grant program fall short, the US Department of Education can "borrow" from the second fiscal year's appropriations to help fund the shortfall. When the shortfalls are relatively small, the US Department of Education can continue in this manner for several years before Congress has to pass a supplemental appropriation to eliminate the shortfall. This time, however, the funding shortfall was large enough that it would have required cutting the next year's maximum Pell Grant.

Q. How will the EFC cutoff for Pell Grant eligibility be affected?

A. The expected family contribution (EFC) eligibility cutoff will be based on 95% of the overall maximum Pell Grant, as opposed to just the discretionary maximum. The EFC eligibility cutoff for 2010-2011 will be $5,273, up from $4,617. Students with an EFC less than this threshold will qualify for a Pell Grant. This should increase the number of Pell Grant recipients by about 240,000.

Q. Will the Pell Grant now be a true entitlement program?

A. Unfortunately, no. The Pell Grant is still funded through a combination of discretionary and mandatory funding, so it is still not a true entitlement program. Entitlement programs are funded with only mandatory funding.

Since the Pell Grant is not a true entitlement, it is possible that the maximum Pell Grant could be cut as it was in 2008, when the maximum Pell Grant was cut from $4,800 to $4,731 due to an across-the-board budget cut. Such a scenario is likely given the prospect of big budget deficits for the next several years.

Q. How does the Direct Loan program save money over the FFEL program?

A. The Direct Loan program saves money for three main reasons. First, the federal government has a lower cost of funds than FFELP lenders. The federal government can borrow at Treasury rates, which are currently very close to 0%. This yields a competitive advantage to the Direct Loan program. Second, by "eliminating the middleman" the federal government gets to keep more of the spread from the federal education loans for itself. These loans are profitable, despite being made to borrowers without any collateral and without regard to credit quality, in part because of the federal government's strong powers to compel payment of defaulted loans. Proponents of the Direct Loan program also argue that the government bears the risk of default and so should derive all of the financial benefits. Third, economies of scale permit more cost-effective servicing of loans, since fewer lenders will be servicing loans. The US Department of Education's contracts with the four servicers pay the servicers about one third less on a unit basis than the lenders had previously charged for servicing in securitizations of their own FFELP loan portfolios, as is demonstrated in the following table. The servicing contracts pay even lower rates for borrowers who are in a deferment or forbearance, delinquent or in default.

Q. Why did the Congressional Budget Office (CBO) reduce the savings estimate?

A. When the CBO originally scored the legislation in February 2009, it estimated savings of $87 billion. This figure dropped to $68 billion when the legislation was rescored in March 2010, a $20 billion decrease. Most of the decrease, however, was due to colleges switching to the Direct Loan program on their own in anticipation of the expiration of the ECASLA liquidity provisions and uncertainty about the future of the FFEL program. The federal government is still realizing the savings from these colleges switching to the Direct Loan program, but the legislation cannot claim credit for the savings.

Q. How realistic are the savings estimates? Is the Direct Loan program really going to save money over the FFEL program?

A. It is easy to quibble over the savings estimates, in part because the estimates are extremely sensitive to economic assumptions. The CBO scoring also does not consider market risk and a variety of other factors, so it overstates the savings. The actual savings will probably be much closer to the estimates prepared by the Office of Management and Budget (OMB).

Regardless of which savings estimate one uses, the Direct Loan program will still save billions of dollars more than the alternatives. It is very difficult for Congress to ignore an opportunity to increase spending on student aid at no cost to the taxpayer. Congress decided that this was more important than saving several thousand FFELP jobs and avoiding the unknown potential for disruption during the transition to the Direct Loan program.

The accuracy of the CBO estimates does not matter in the strange calculus that operates on Capitol Hill. The CBO estimates may be flawed, but at least they are nonpartisan, and they provide the justification for increased spending on student aid. CBO estimates were used in the Higher Education Reconciliation Act of 2005, when Republicans dominated Congress, just as they are used in the Health Care and Education Reconciliation Act of 2009, when Democrats dominate Congress.