Believe it or not, this federal program actually sparked today’s fierce competition by introducing a streamlined way of delivering student loans. Private lenders had to scramble to catch up, and they don’t want the Feds getting ahead of them again. So they’re blowing in the ears of their congressional buddies, hoping for legislative action to clip the government’s wings.
Money for millions:The guaranteed-student-loan program is providing $32 billion for fiscal year 1999 to 8.7 million students. Young undergraduates can borrow up to $23,000; graduate students are eligible for more. A federal formula determines whether you have financial need. If you do, the government pays the loan interest while you’re in school. If not, you pay.
Traditionally, loans were offered solely through private or state-linked lenders (some 4,100 of them today) and administered by special guaranty agencies. The business is virtually risk-free. Congress sets the fees and interest rates that students pay. Lenders receive subsidies to assure them a reasonable return. If a student defaults, the Treasury covers 98 percent of the loss.
For years this system rattled on inefficiently, driving schools and students nuts. The lenders all had different application forms and communicated with the guaranty agencies in different ways. Some gave good service, others didn’t. Schools complained that the money didn’t always arrive by the day tuition was due.
Almost nobody was competing on price. Every time Congress proposed a cut in student costs, the lenders screamed that they couldn’t manage on a nickel less. Today’s official price structure calls for 4 percent in upfront fees–a 3 percent origination fee to offset some of the government’s costs and a 1 percent loan-insurance fee to cover potential defaults. Interest rates, which change every July 1, currently stand at 6.92 percent for the majority of student borrowers.
The Direct Loan program ended the lenders’ sweet cartel in 1994. It let students borrow directly from the Treasury through their school’s office of student aid. That cut out the banks and other middlemen, at potential savings of many billions of dollars in taxpayer subsidies. It also created a faster, simpler payment system that left most of the private lenders in the dust. So far, about one third of the eligible schools have joined the plan.
The private lenders tried to snuff the program from the very start. When they failed, they entered prayer mode–hoping the Education Department would make a royal mess of things. When Direct Loans succeeded, the lenders took a radical step. They decided to compete.
First, they cleaned up their act–becoming more efficient, improving their electronic systems and addressing the schools’ complaints. “There has been more improvement in the student-loan program in the last three to five years than there was in the previous 15,” says William Hiss, vice president for administrative services at Bates College in Lewiston, Maine.
Next, they cut their price. For example:
This wave of price-cutting turned the competitive situation on its ear. Suddenly, Direct Loans didn’t look so hot in certain states. Last year the program lost a few schools. To stay in the game, Education will cut 1 percent from its borrowers’ upfront costs, effective Aug. 15. It also announced small interest-rate cuts for electronic payments and students, newly leaving school, who gather their borrowings into a single loan.
The government’s action brought private and state-based lenders back to the barricades. The law, they say, doesn’t allow the Direct Loan program to cut its price. The Ed Department disputes this. Congress is making inquiries. The bankers are mulling a legal challenge, but action isn’t expected now. Neither Congress nor lenders want to sound antistudent in an election year.
But having pricked the private lenders to improve, the government faces a harder road. Energized, the banks will compete on service and technology as well as price, says William Beckman, president of Citibank’s student-lending arm. The Ed Department won’t be able to keep up if Congress questions every move.
With loan programs in flux, the schools should try to work with them all, rather than stay exclusively in (or out) of the federal plan. Students should check their options to get the price cuts while they last. Direct lending proved that there’s value to having two competing loan-delivery systems–especially when the taxpayers can save money, too. If Congress interferes with the Ed Department’s success, you might not have it this good again.
