Federal loans offer limited amounts but lowest cost

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Low-interest federal loans are the backbone of the nation's financial aid system, but the amounts available to students haven't kept pace with inflation and escalating college costs, policy experts said.

To fill the gap, students over the past decade increasingly have turned to private loans, which charge higher fees and interest rates. Now, access to private loans is tightening with the subprime credit crunch, creating a new problem.

A federal law provided modest increases this school year in some federal loan limits; another law cuts interest rates on certain federal loans issued as of July 1. But some policy analysts and financial-aid officers are calling for still bigger infusions of cash into the programs, which date to the 1950s.

Higher borrowing limits on federal loans "would protect students from having to purchase the extra credit on the private market," said Patricia Steele, policy analyst at the College Board and co-author of the organization's 2007 "Trends in Student Aid" report.

"I think that there is certainly discussion about increasing loan limits," Dr. Steele said.

The College Board, which gives the SAT college entrance exam, has formed a Rethinking Student Aid task force to study refinements to the student aid system.

Higher borrowing limits on federal loans would be the second choice for Bob Thorn, director of financial aid at California University of Pennsylvania.

"Really, we'd like to see more help from the federal government on the grant side," Mr. Thorn said.

Pell grants -- the main federal grant program -- target needy students. The government last school year spent about $12.9 billion on grants to about 5.2 million students, according to the College Board.

In comparison, the government provided or guaranteed 12.3 million loans last school year. They totaled nearly $59.6 billion, up from about $28.8 billion in 1996-97, according to the College Board.

That's an increase of 107 percent over 10 years.

Adjusted for inflation, however, the increase totaled 61 percent, the study said. Even that figure fails to tell the whole story.

More students use loans today than 10 years ago, meaning most of the increased loan volume has been spread across larger college enrollments, not used to increase the average loan amount.

At the same time, federal grants and loans are paying for a smaller portion of ever-rising college costs. About a decade ago, federal grants and loans made up 66 percent of aid packages; last school year, they accounted for 58 percent, according to the College Board.

According to the study, the programs offering a better deal to students declined in inflation-adjusted dollars or grew at a slower rate over the past decade than those costing students more. Over that decade, the portion made up of the need-based, subsidized Stafford loans -- one of the best deals -- fell from 54 percent to 32 percent.

Federal loans are available to students at private, public, trade and career postsecondary schools.

Students begin the borrowing process by filling out the Free Application for Federal Student Aid, which can be done online at www.fafsa.ed.gov.

Depending on the student or family circumstances, the federal government has three main types of loans: Perkins, Stafford and PLUS. Some come in more than one form, such as the Stafford, which can be subsidized -- the government pays the interest while the student is in school -- or unsubsidized -- the student accrues the interest.

Stafford and PLUS loans are offered through the William D. Ford Direct Loan program, in which loans are made by the federal government, or by the Federal Family Education Loan Program, in which loans made by private lenders are guaranteed by the federal government.

The best borrowing option currently is the Perkins loan, which has an interest rate of 5 percent and no loan fees. Perkins loans are limited to exceptionally needy students.

The program offers up to $4,000 annually to undergraduates and $6,000 annually to graduate students. Lifetime limits are $20,000 for undergraduates and $40,000 for undergraduate and graduate studies combined.

The government pays interest while students are enrolled; for nine months after they graduate or leave school; and during deferments for economic hardship or other reasons.

President Bush last week proposed elimination of Perkins loans, calling them "ineffective" and "poorly targeted."

The next-best deal now is a subsidized Stafford loan, with a maximum interest rate of 6 percent next school year for undergraduates.

Subsidized Stafford loans are awarded on the basis of financial need to students enrolled at least half-time. The government pays interest on the loan while students are enrolled; for six months after students graduate or leave school; and during deferments.

Subsidized Stafford loan limits didn't change for a decade, but starting this school year, the limits were increased to $3,500 for first-year and $4,500 for second-year students, thanks to the Higher Education Reconciliation Act of 2005. The limit for following years remained at $5,500 annually.

In addition, the College Cost Reduction and Access Act of 2007 gives temporary interest rate cuts on subsidized undergraduate Stafford loans. The maximum rate is now 6.8 percent, though private lenders sometimes entice students with discounts. The maximum rate drops to 6 percent for loans issued as of July 1; to 5.6 percent for those issued as of July 1, 2009; to 4.5 percent for those issued as of July 1, 2010; and to 3.4 percent for those issued as of July 1, 2011. The maximum rate reverts to 6.8 percent in 2012.

The government also offers an unsubsidized Stafford loan, which isn't based on financial need. The government guarantees these loans, and they come with a below-market interest rate of 6.8 percent. But the government never pays the interest.

The combined total of subsidized and unsubsidized Stafford loans cannot exceed $3,500 the first year, $4,500 the second year and $5,500 in each subsequent year for undergraduates.

Exceptions are made for independent undergraduates and dependent undergraduates whose parents are denied federal PLUS loans. Those students may borrow--through the unsubsidized program--up to an additional $4,000 annually during their first two years of school and up to an additional $5,000 annually in following years.

The government has lifetime caps on subsidized and unsubsidized Stafford loans, such as $23,000 (subsidized, unsubsidized or combined) for a dependent undergraduate.

Graduate students may borrow up to $20,500 annually in Stafford loans, including $8,500 in subsidized loans, if eligible. The maximum interest rate is 6.8 percent.

In addition to interest rates, Stafford loan fees also are being reduced, which may prompt some private lenders to get out of the Stafford loan business, putting a heavier burden on the federal government, said Keith New, spokesman for the Pennsylvania Higher Education Assistance Agency. At least, he said, the declining profitability of Stafford loans means lenders will be less likely to offer discounts to students.

The government also offers PLUS loans to graduate and professional students and parents of undergraduates. Amounts are based on college costs and other aid received, but there's no lifetime limit.

Interest rates are 7.9 percent on loans provided directly by the government and 8.5 percent on those provided by private lenders. Graduate students begin the borrowing process by filling out the FAFSA, while parents fill out a separate loan application and undergo a credit check. A 4 percent fee is deducted from disbursements.

In inflation-adjusted dollars, Perkins loan volume declined 14 percent and subsidized Stafford volume increased 19 percent from 1996-97 through 2006-07. Unsubsidized Stafford and PLUS loans, both more costly for families, grew 102 percent and 232 percent, respectively, according to the College Board.

While students may work off some of their loans -- the College Cost Reduction and Access Act extends that option to some in public service jobs -- only in rare cases may loans be completely discharged.

"Death would do it," Mr. New said.


Joe Smydo can be reached at jsmydo@post-gazette.com or 412-263-1548.


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