Uneven Benefits

While debating a key higher education bill last month, top Republicans on the House Committee on Education and Labor made the case that some direct student loan borrowers are being shortchanged. During a markup of legislation to reauthorize the Higher Education Act, Congressmen Rick Keller (R-FL) and Howard P. (Buck) McKeon (R-CA) argued that lenders in the Federal Family Education Loan (FFEL) program generally provide more generous upfront and back-end discounts on federal loans than the Education Department makes available to borrowers who obtain loans through the competing direct lending program.

The two lawmakers argued that students attending schools that participate in the Direct Loan program should have access to the same types of rebates that their counterparts at FFEL schools are offered. And on that point, we agree.

But instead of offering a solution that would even the playing field between the two loan programs, and allow them to compete solely on their merits, Keller and McKeon are once again pushing a proposal that would reward their friends in the student loan industry by undermining the Direct Loan program.

The proposal, which Keller introduced as an amendment to the reauthorization legislation and is likely to offer again when the bill reaches the House floor shortly, would essentially force colleges that participate in the Direct Loan program to allow their students to obtain federal loans from banks and other lenders in the FFEL program. Speaking at the markup, Keller explained that his amendment would benefit borrowers by providing them with access to discounts that banks offer:

“Let’s say that you’re at one of these direct lending schools. As of today, you would pay a 6.8 percent interest rate and you would pay a two percent origination fee. By allowing competition and student choice, instead of getting a 6.8 percent rate, perhaps a student could get a FFEL loan for 6.7 percent. Instead of paying the government required two percent origination fee, perhaps a FFEL lender would have a one percent origination fee or no origination fee.”

In other words, Keller is saying that the only way to deal with the unlevel playing field is to tilt it by making it easier for banks to lure students away from direct lending. This argument ignores the fact that most lenders didn’t offer discounts on federal loans until the late 1990s, as a way to better compete against direct lending. Should the Direct Loan program wither away, the willingness of lenders to continue to offer rebates is likely to decline.

Keller’s argument also ignore the fact that many of the back-end discounts that FFEL lenders offer are a mirage. They often come with so many conditions attached — such as 48 continuous months of on-time payments — that only a relatively small proportion of students ever qualify for them. In addition, many or the promised discounts disappear when lenders sell the loans to secondary markets.

Still, we do agree that all federal loan borrowers — no matter what schools they attend — should be eligible for the same student loan benefits. To achieve this goal, we would urge lawmakers to compel Education Secretary Margaret Spellings to use her authority to match the most generous discounts on interest rates and fees that lenders are providing. For example, if Spellings reduced Direct Loan interest rates by 1 percentage point from the maximum rate — as some FFEL lenders, like MyRichUncle, have– the typical student borrower would save $1,000 in payments over the life of his or her loans.

Section 455 of the Higher Education Act mandates that the Direct Loan program provide “the same terms, conditions, and benefits” as the FFEL program. Twice, in 1999 and 2000, Education Secretary Richard Riley enforced this provision and lowered Direct Loan program fees to match the lower fees that FFEL lenders were offering. The current Education Secretary has not followed suit, even though the Bush Administration has recognized the Secretary’s authority to do so.

Requiring the Secretary to match the most generous discounts available in FFEL would not just benefit students at Direct Loan schools, but potentially all borrowers. For example, an across-the-board reduction in the Direct Loan interest rates by a percentage point would presumably motivate other lenders to do the same to remain competitive with direct lending.

During the markup on the House bill, Keller stressed the importance of “ensuring all students access to the lowest cost loans.” We agree and hope Congress will mandate the Education Secretary to use her authority to make that important goal a reality.