The interest rate paid by students on both guaranteed loans and direct loans is fixed and is set by Congress. In the case of guaranteed loans, the government pays a subsidy to lenders that make the loans and also guarantees the amounts loaned, almost completely protecting lenders from losses. Private loans usually have worse terms than either type of federal loan and the interest rates on private loans can change over time. To learn more about loan terms, please see the Student Loan Guide.
Much more attention is now paid to the student loan business, which provides tens of billions of dollars a year in financing to students and families. In 2007 a series of scandals rocked the industry, as investigations by state attorneys general and by lawmakers in Washington turned up questionable relationships between some college financial aid offices, which could direct students to particular lenders, and loan companies seeking to gain business.
More recently, in 2008, student lending has been shaken by the credit crisis, which threatened to cut off the supply of student loans from private lenders by depriving them of a means of raising fresh capital. Many lenders depended on being able to sell loans they made in order to get money to make new loans, and investors' interest in buying student loans - along with home loans and all manner of debt - fell dramatically. To bolster the industry, the federal government stepped in as a buyer of federally guaranteed loans.
Now, in 2009, the Obama Administration has proposed scrapping the guaranteed loan program entirely, such that all federal loans would be made directly by the government. The administration predicts that this step would save billions of dollars in subsidy payments to lenders, and wants to redirect that money to pay for expanded grant aid to needy students.
The plan is the main money-saving component of Mr. Obama's education agenda, which includes a sweeping overhaul of financial aid programs. The Congressional Budget Office says replacing subsidized loans made by private banks with direct government lending would save $94 billion over the next decade, money that Mr. Obama would use to expand Pell grants for the poorest students.
But the proposal has ignited one of the most fractious policy fights this year.
Because it would make spending on Pell grants mandatory, limiting congressional control, powerful appropriators are balking at it. Republicans say the plan is proof that Mr. Obama is trying to vastly expand government. Democrats are divided, with lawmakers from districts where lenders are big employers already drawing battle lines.
At the same time, the private loan industry, which would have collapsed without a government rescue last year, has begun lobbying aggressively to save a program that has generated giant profits with very little risk.
For lenders, the stakes are huge. Sallie Mae, the giant student lender, reported that despite losing $213 million in 2008, it paid its chief executive more than $4.6 million in cash and stock and its vice chairman more than $13.2 million in cash and stock, including the use of a company plane. The company, which did not receive money under the $700 billion financial system bailout and is not subject to pay restrictions, also disbursed cash bonuses of up to $600,000 to other executives. Sallie Mae said that executive compensation was lower in 2008 than 2007 and that the stock awards were worthless in the current market.
Critics of the subsidized loan system, called the Federal Family Education Loan Program, say private lenders have collected hefty fees for decades on loans that are risk-free because the government guarantees repayment up to 97 percent. With the government directly or indirectly financing virtually all federal student loans because of the financial crisis, the critics say there is no reason to continue a program that was intended to inject private capital into the education lending system.
Under the subsidized loan program, the government pays lenders like Citigroup, Bank of America and Sallie Mae, with both the subsidy and the maximum interest rate for borrowers set by Congress. Students are steered to the government's direct program or to outside lenders, depending on their school's preference.
Private lenders say they still provide valuable service, marketing, customer relations, billing, default prevention and collection of delinquent loans. The lenders say the budget savings could be achieved without ending their role and are pushing to keep the system in place, including an arrangement approved by Congress last year by which they are paid to originate loans but can resell them to the government.
The president's plan would use the money from direct lending to help increase Pell grants and make them mandatory, with annual increases tied to inflation, providing a much-needed measure of certainty for students. That would limit congressional control over the grants, an idea appropriators are not keen on, but the White House and congressional leaders say they are open to negotiation.
Whatever the political wrangling, the increases in dollar amounts that would be available under the president's proposal are not huge - a few hundred dollars more in available grants, for example - but for many students, that may go a long way.