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Student Loan Market Facing Overhaul

President Barack Obama is trying to remake the government’s student loan program by eliminating the middle man.

Currently, college students can either borrow federal loans directly from the government or through lenders like Wells Fargo , Bank of America , Sallie Mae and Citi .

Uncle Sam and money
Uncle Sam and money

In his budget, Obama outlined his plan to cut private lenders out of the picture and instead expand the government’s program—called Direct Loans—and have all students take out federal loans directly from the government.

The program that would be eliminated is called the Federal Family Education Loans, and it currently works like this: the government pays the lenders to originate the federal loans to the student. The government sets the interest rates for the loans and fees, while paying lenders to handle the customer service aspect, like collecting payments and managing a consumer Web site.

“There’s only one real difference between Direct Loans and private FFEL loans,” Obama explained during a recent speech. “It’s that under the FFEL program, taxpayers are paying banks a premium to act as middlemen—a premium that costs the American people billions of dollars each year.”

The idea is to use the savings to build the government's loan program and help fund the Pell Grant program for low-income families.

If Obama’s plan to kill the FFEL program passes, it won’t be finalized until this fall and won’t go into effect until July 2010. “No families should be worrying about getting federal loans for this fall,” said Kevin Bruns, executive director at America’s Student Loan Providers, a coalition of lenders and guarantors.

Here’s what the shake-up could mean for students entering school next year.

Pell Grant Protected

Currently, Congress has to decide every year if it will continue to fund the Pell Grant. Under Obama’s plan, renewal will be automatic.

What's more, Congress will no longer have to set the maximum qualifying amount on an annual basis students can get in grants. For next year, the amount is capped at $5,550. Under Obama’s plan, the maximum amount of the grant is tied to the Consumer Price Index, plus 1 percent.

“This keeps it in track with inflation and the price of college, as it goes up,” said Angela Peoples, legislative director of the United States Student Association.

Less Competition

Eliminating banks from the mix means the government will be the only one offering federal loans, removing the chance that students could get discounts on their loans, say critics of Obama’s plan.

Before the credit crisis, lenders offered lower fees and other discounts in order to attract customers. Now, amid a tighter credit environment, lenders have cut back on deals.

However, many lenders still offer students a quarter percent off their interest rates if they set up automatic monthly payments from their checking accounts, says Mark Kantrowitz, publisher of FinAid.org, a Web site that tracks the college financial aid industry. Those types of discounts could disappear.

Customer Service

Experts who follow the student loan industry say that customer service may be affected by the changes. The banks that originate federal loans are paid to offer customer service including call centers and Web sites.

The big question is whether the government can handle the volume of new loans and match the private lenders' customer service.

Currently, more schools in the country offer federal loans from private lenders then from the government’s Direct Loan program. During the 2008-2009 school year, 4,424 schools issued 11.2 million loans from private lenders, while just 1,620 schools issued 4.5 million loans directly from the government, according to the Department of Education.

If Obama's plan succeeds, students won't even notice a difference at first because they won't really have to deal with the lender until after graduation when repayment typically begins.

"For now, this change is seamless," says Bob Friedman, university director of student finance at Yeshiva University.

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