During the ’92 Campaign, Bill Clinton vowed to “scrap the existing student-loan program” and replace it with one that would allow borrowers to repay loans as a percentage of their income. Of course, he vowed to do a lot of things. But on July 1, the Department of Education began issuing direct student loans to be repaid on the basis of “income contingency.”
In the first year, only 5 percent — about $1 billion — of the total government-backed loan pool will be in direct loans. The remainder will still be handled by banks and other private lenders. But next year the share of direct loans is scheduled to jump to 40 percent and soon after make up the majority of new student lending.
We talked with David Longanecker, the Department of Education’s assistant secretary for postsecondary education, about the changes in financing a college education. For further details, call (800) 433-3243.
What is a direct student loan?
A loan that’s made directly from the federal government to students through the schools. The capital comes from the federal government. That’s quite a bit different from the old loan program, where we essentially paid private banks to provide the capital.
The reason we changed is real straightforward. The old way cost too much, it was impossible for us to manage, and we had all of the responsibility but virtually none of the authority. The authority was controlled by those banks and by some things we called guarantee agencies, which we also paid. We were paying a lot of middlemen. They were doing a nice — a decent job in some respects, but we were paying an awful lot for that.
And they didn’t want to provide the repayment terms we believed students needed when they came out of school. We wanted a program where students paid back not based on how much they borrowed but on how much their income allowed them to pay back. So we developed what we call an income-contingent loan-repayment program.
If they get out of school and don’t get a great job for a while, that’s OK; they won’t have to pay so much on their loan. If they take a public-service job or for some reason their investment in themselves doesn’t pay off substantially, we’ll take the hit as the federal government — and intentionally so. If they go into public law instead of corporate law and as a result give us something back in a different way, then they won’t have to pay back as much eventually.
We’re also allowing students who took out old student loans who want to convert those into direct loans so that they can participate in income contingency or some of the other features to do that.
Do banks have any role in direct lending?
No, unless they compete as a contractor for the service. We don’t actually do this job of servicing these loans ourselves. We’ve contracted for that service. In the past, banks got paid the same amount whether they provided good or poor service. Now our contracts are based on quality of service. Some people have said we moved away from a privatization model. In fact, we think we moved closer to one. We’re now contracting for service on the basis of price and quality; that’s what the private market is best at.
If the loan is going directly to the school, does that mean the student doesn’t have to mess around getting it before classes begin?
That’s correct. We still recommend they apply for financial aid as early as possible so that they get the full array of potential financial assistance. But a student can go to a school now and apply, and that application will be processed by our central processor, determining eligibility for Pell Grants, for student loans, and that will all essentially be available in their account within 72 hours.
You can process this in 72 hours?
Yes. There’s a single application form we created so that students can now file for all federal student financial assistance with one form. There used to be an array of forms that a student had to fill out.
Students fill out that new form. They can do that electronically at their school, they can do it on a computer — it’s transmitted electronically to us — or they can do it on paper. Either way we will process it as soon as we receive it. Within 72 hours the school will have the eligibility of that student for the various federal programs.
The program began July 1. How’s it working?
Everybody is extremely pleased with it at this point. You know, this is a pretty phenomenal feat. This program was passed last August. We selected the institutions for the first phase in November. We selected our contractor in December and since then have been working with institutions to develop the software packages and all. By May 15 we were in a beta testing phase and by June 15 were processing applications.
Was there any model for this program? Or is this something that was hatched fresh?
We’d like to claim it as our genius, but the idea of income contingency has been around for about 25 years.
Does the IRS have a role in collecting?
It may. At the present time it doesn’t, except that they give us income information when a student selects income contingency, so they provide us the most recent information on that person each year so that we know what their income is.
The IRS provides that to you?
The IRS provides that. That’s their current role. In the future they may actually become a partner in the collection of these loans. If their collection system can provide us with accountability and students with the customer service they deserve, that might be a very viable way for us to go. But we’re still investigating.
If direct loans are such a great idea, what took so long?
One reason is that there was so much money being made. The banks, the secondary markets and the others, these folks provided service, no doubt, but they did so in an extremely profitable way. This was the second most profitable component of most banks’ portfolios.
They were making risk-free loans, essentially.
Yeah. Their yield was assured, and it was higher than almost anything else in their portfolio. Because they were making that kind of money and there was such an array of actors out there, it was almost politically impossible to change.
What happened that made it possible?
Three things. One is that we had increasing evidence in General Accounting Office reports that the program simply wasn’t working, that it was costing too much money and couldn’t be managed effectively because of the array of actors. Two, we had the president running on an initiative that couldn’t be incorporated effectively into the existing program. Income contingency really required a new design.
And then — I almost hate to say this — almost by accident this program was incorporated into the Omnibus Budget Reconciliation Act last year. It had fiscal impacts, and it was put into a budget bill as a cost saver, because it was going to save about $4 billion.
Once it was in that bill, if people wanted to change it, they had to come up with a requisite amount of savings somewhere else. Nobody could do that. We were in a much stronger political position than if we’d had a separate bill. Those forces I’m talking about now had to attack the entire Omnibus Budget Reconciliation Act, and that really created a dilemma for them.