NEWS FROM THE WALL STREET JOURNAL: DECEMBER 22, 2005

Congress Cuts Funding
For Student Loans

Loss of $12.7 Billion Means
That Graduates Will Face Higher
Interest Payments, Fewer Options

By ANNE MARIE CHAKER
Staff Reporter of THE WALL STREET JOURNAL

Congress yesterday cut funding for federal student-loan programs, a move that is expected to increase the debt burden for many future college graduates and their families.

The reduced financing is part of a $40 billion deficit-reduction package passed by the Senate. Federal student-loan programs make up the largest chunk of the spending trims -- $12.7 billion over five years. To help limit spending, Congress raised interest rates on the popular Stafford loans to a fixed 6.8%, even if commercial rates are lower, and cut subsidies to lenders. Other affected programs include Medicaid and pension insurance.

Though it isn't the first time the federal government has made cuts in student-aid programs, it is the largest single cut in dollar terms, and it follows years of increased federal support for these programs. Interest rates on student loans have been kept artificially low by government subsidies to students and lenders. The law also provides for some increased funding for grants for low-income students and other programs.

The Senate passed the bill yesterday -- the tie-breaking vote was cast by Vice President Cheney -- and final passage is considered all but assured. President Bush is expected to sign the bill when it reaches his desk. Many of the changes would take effect July 1, 2006.

The changes aren't expected to reduce the number of those eligible for student loans. Instead, they are expected to result in higher interest payments for many student-loan borrowers, particularly parents of college students. In the 2002-03 school year, more than six million students took federal student loans to pay for college.

The legislation has generated strong opposition from colleges and student advocates. "It threatens to destabilize student-loan programs and raises interest rates higher than they need be," says Sarah Flanagan, vice president for government relations at the National Association of Independent Colleges and Universities.

U.S. House Education and the Workforce Committee Chairman John Boehner, an Ohio Republican, said that the law offers "significant new benefits" to students, "from lower loan fees to higher loan limits to a simplified financial aid application process."

The changes come at a time when families have been struggling with skyrocketing tuition bills. After adjusting for inflation, private-college tuition and fees have increased 37% over the past decade, while public tuition has risen 54%. Today, most college students borrow money to pay for college. Two-thirds of undergraduates graduate with debt; among graduating seniors, the average debt load is $19,202, according to an analysis of data from the Department of Education's National Postsecondary Student Aid Study. That doesn't include any debt that their parents might incur.

Here is how the bill will affect two of the most popular student-loan programs:

Stafford loans. These are the most ubiquitous type of student loans, largely because students don't have to demonstrate need in order to secure one. The interest rate on a Stafford loan is variable and reset annually, depending on a formula that looks at prevailing market interest rates. Today, that rate is as low as 4.7%, and students can lock it in thanks to the Federal Consolidation Loan Program, which allows for a one-time opportunity to refinance.

Under the new legislation, the interest rate changes to a fixed rate of 6.8% starting July 1, 2006, on Stafford loans. While that is significantly higher than what students are currently paying, it is only slightly higher than what the average repayment rate has been since 1992-93, when the current interest-rate calculus was instituted, and is still below the current cap of 8.25%.

Parent Loans for Undergraduate Students. Under this program, money is lent directly to parents rather than students. As with Stafford loans, the variable rate is reset every year, though it is capped at 9%.

PLUS loans will become far less attractive under the new law, as interest rates on these loans will be fixed at 8.5% -- near the cap of 9%. Currently, the repayment rate on these loans is set at 6.1%. The new law, though, will allow graduate and professional students to borrow PLUS loans, rather than just parents of dependent undergraduate students.

Until now, students could lock in a single, fixed interest rate on their loans when they consolidated them. Over the past year, many lenders said they saw a record number of consolidations as interest rates on federal student loans had hit an all-time low.

Yet the new law, by setting fixed rates for student loans, makes consolidating less attractive. "It essentially removes any financial incentive or benefit to consolidate," says Mark Kantrowitz, a Pittsburgh-based financial-aid expert, who points out that the only remaining incentives for consolidating include a single monthly payment and access to a variety of alternate repayment provisions, such as extending repayment when a student is experiencing financial difficulty.

When compared with today's low rates, switching to fixed rates would cost students and their parents thousands of dollars over the life of the loan, according to estimates by Mr. Kantrowitz. If a student consolidated a typical Stafford loan balance of $20,000 at the new rate compared with the current low rate, he would be paying over $2,000 more in interest over a standard 10-year life of the loan. With PLUS, parents would be paying nearly $3,000 more.

Ally McWilliams, a community-college student transferring next spring to the University of Missouri-Columbia, believes the new law will increase her debt load. While the new fixed rates might look good if rates go back up, she says she expects that in the end, the changes are "not a fair deal for students" and amount to trying to reduce the deficit "on the backs of students."

At Harvard College, there is concern that the many students going to graduate school "will be borrowing a tremendous amount of money, and the increase in the interest rate is really going to have an unfortunate impact on them," says Sally Donahue, the school's director of financial aid.

The law will also cut certain fees that students have to pay on their loans to 1% by 2010 from the current 4%.