SAFRA – Big Reform in the Student Aid Industry

On March 30, 2010, President Obama signed the Student Aid Fiscal Responsibility Act (SAFRA) into law. This landmark piece of reform legislation is intended to reboot the floundering student loan industry by redirecting all new federal loans through the Department of Education, bolstering several pro-financial aid initiatives, and ending the hotly-contested Federal Family Education Loan (FFEL) Program. I would like to walk you through these changes, explain how they will affect the average student, and attempt to answer any burning questions you may have about them.

FFEL, and Why It’s Going Away

The Federal Family Education Loan Program was established in 1965 as a way to provide access to college for students requiring financial aid. At the time, the government was not participating heavily in the origination of student loans, but recognized the need. In order to create a less credit-heavy lending option for students, the government began to allow private banks to originate loans for students that were backed with federal funds. Essentially, this created a near risk-free environment for private banks to lend money to students and earn interest on the borrowed funds. Further, these banks have been paid subsidies as an incentive to create these loans; the result is them getting paid by the government to make a student loan that is guaranteed money for the bank, even if the borrower defaults. The long and short: the banks win on both sides of the equation, and make a ton of money doing very little.

To add insult to the injury, many FFEL lenders have been accused of purposely providing poor customer service in an attempt to increase delinquency rates. This difference can be easily seen when one looks at the default rates for 2009: 7.2% for FFEL, 4.8% for the Direct Loan program (data sourced from ED.gov.) This activity supposedly is overlooked due to the much larger commission a FFEL bank’s collection department is authorized to take for recovering a defaulted FFEL student loan; in some cases it has been reported to be as high as 38.5% of the loan’s balance (The Huffington Post).

The effect of the SAFRA bill is these subsidies and current relationships between private bank and the federal government dissolve. Ideally, this will liberate up to $61 billion over the next 10 years to be reinvested in other initiatives (such as the Pell Grant program) and potentially pay down some of the federal deficit. Keep in mind that much of this is sensationalism however, considering the fact that our total deficit is currently in the region of $12.7 trillion; the estimated $10 billion would be a drop in the bucket toward paying down our national debt, but every bit counts.

Federal Student Loan Restructuring

As of July 2010, all new federal student loans will be originated through the Department of Education’s Federal Direct Loan Program (FDLP). In the past, FFEL banks were allowed to originate federal loans, but due to the issues listed above and shady practices, Congress has reached a consensus that the program is overdue for the guillotine and needs to end. Thus, the relationship between private bank and government is set to change in a way that is mostly invisible to the borrower. This difference is in the execution: although new loans will be created by FDLP, the government will now require private banks and non-profit entities to compete in order to service them. They plan to make this attractive to their former FFEL partners by paying premium and competitive market rates for the first 100,000 loans serviced per bank. The end result is this: the Department of Education makes your loan, but the customer service is handled by a private bank or large non-profit. Supposedly this will provide a higher quality experience for borrowers, but the reality of the change is yet to be seen.

As someone with a lot of experience with finance and the business world, I personally do not understand why a private bank would want to service federal loans. It can’t be lucrative enough to make the entire process worthwhile, and no extra funds appear on the banks’ balance sheets because the government is handling the money on both sides of the equation. My sixth sense says there are other kickbacks in place for the banks involved (possibly tax breaks, or something similar.) It is likely that lobbyists and media will be keeping a very close eye on whatever transpires in this arena; if you are interested in following how this process is evolving, check a trusted news source (such as the Wall Street Journal) regularly.

If you are currently a student or parental borrower, your existing federal loans will remain unchanged by this switch. The only difference you may see going forward is if you attend a FFEL school; they will be migrating to the Direct Loan Program in the next six months. Originally, most schools were one or the other exclusively depending on what type of benefits they could get for their students from each institution. After July, any new loans you take out will all be through FDLP, at a lower interest rate, and with a more flexible array of repayment plans.

Improvements to the IBR Program

Income Based Repayment (IBR) is one of the best things to ever happen to student borrowers. Essentially, if your total payments for the year equate to higher than 15% of your annual income, you are eligible to have your payments drastically lowered. For instance, under IBR, an income of $15,000 (for a household size of one) or less would make your monthly payment on all federal student loans $0. That’s right, no payments at all. As the household size increases, the maximum income level to qualify for IBR rises as well. The Student Loan Network has assembled a great chart on Income Based Repayment information that presents the data in an easy-to-digest format.

The benefits of IBR don’t stop there. In addition to potentially having your monthly payments significantly reduced (or eliminated), you actually can have the loans forgiven if they are in good standing and all payments are made on time for a certain amount of time. In some cases, federal student loans will be forgiven after 10 years (this is based on a “hot fields” list of desirable professions) and 25 years for everyone else. If you are wondering what is exactly meant by loan “forgiveness”, it means your loan gets cancelled, and you no longer have to pay it back or have the debt sitting on your credit history.

So what are the technical changes to this program? Thanks to a $1.5 billion infusion of funds provided by cutting the FFEL program, eligibility requirements are going to be relaxed further and loan forgiveness will be accelerated. Assuming no amendments or further changes to SAFRA, starting in 2014, the payments to income ratio for eligibility is being dropped to 10%. This is fantastic given the amount of debt the average student graduates with (federal and otherwise) and allows for greater ability to manage finances and afford living costs. Additionally, instead of the previous 25-year period before loan forgiveness, the program is being accelerated to 20 years. This is an absolutely major win for responsible student borrowers.

Ongoing Pell Grant Enhancements

The Pell Grant program is widely appreciated in the financial aid industry as a resource of funds for low-income individuals to help afford the cost of education. Although the purchasing power parity of this type of grant has fallen sharply over the years — largely due to inflation and the rapid growth of tuition costs — it is still a significant help to needy students that does not require repayment. The majority of the cost savings from cutting the FFEL program are planned on being redirected to the Pell Grant program, infusing an estimated $49.5 billion over the next 10 years.

The effects of this investment are adding at least a million more recipients per year, raising the award amounts, and linking future grant awards to popular economic indicators in the future. Currently, the maximum Pell Grant award is set to be $5,550 for 2010; the new legislation increases the award up to $5,975 in 2019. In addition, the Pell Grant program is going to be linked to the Consumer Price Index (CPI) starting in 2014, which will help the grant awards keep pace with inflation and maintain their buying power.

What The Changes Mean To You

As a current or future student borrower, the massive overhaul probably seems intimidating and difficult to understand. The bottom line of the legislation is to improve access to financial aid and make school more affordable for all levels of family income. For low income families, this comes in the form of increased grants; for everyone else, improved repayment programs and a simplified loan application process. Very little will be different on the front end for most students and parents, and again, there will be no change to existing loans.

If you are concerned about finding money for school, keep in mind that there are options other than federal aid available too. Scholarships are an excellent resource because they do not need to be paid back and you can find them in amounts ranging up into the thousands of dollars. Websites like StudentScholarshipSearch.com and ScholarshipPoints.com are quite popular for finding scholarship money and cost nothing to join. In the end, affording college is always a balance of savings, smart borrowing, and maximizing the amount of scholarships and grants possible to finance your education. It is entirely possible to get a degree without putting yourself into insane amounts of debt, so take the time to read informative financial aid literature and educate yourself on finding money for school.