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Can Education Dept. Handle Student Loans Solo?

In addition to the health care bill, congressional Democrats passed another sweeping proposal from the Obama administration — one that ends the government's partnership with private lenders and makes the U.S. Education Department solely responsible for issuing government-backed student loans.

"We'll see how that goes," laughs Melissa Gregory, director of financial aid at Montgomery College in suburban Maryland. More than 22,000 students at her two-year college rely on government-backed loans. Gregory isn't sure the Education Department can handle the jump in student loan applications, with private lenders out of the picture beginning July 1.

"Can they handle the service component? Calls from students, explaining things to students — that will be a real challenge for the Department of Education," she says, "and it's one they say they're ready to handle."


Eliminating The Middleman

It's not that the department hasn't done it before. The direct-lending program has been in place since 1993 and already accounts for almost half of all federal student loans. But that number will more than double in the next three months.

Can they handle the service component? Calls from students, explaining things to students -- that will be a real challenge for the Department of Education.

Marianne Mullan, 20, has her own concerns. She's graduating from Montgomery College in May and will have to borrow $25,000 to attend a private four-year college in Ohio in the fall. She worries about having only one lender to choose from.

"Getting completely rid of the private sector, I'm not sure would be the best idea," she says. "I think direct lending has great reviews right now, but what is it going to look like in 10 years?"

Richard Dancy, a 22-year-old theater major, says he's not nervous about the switch to direct lending; he hates dealing with banks.


"Because of my immediate need for funds, I had to go and get the money from a private lender," he says, "and the interest rate is double on the private loan — 12.5 to 13 percent."

Dancy says direct lending can't possibly be more stressful or complicated than what's been in place until now.

"You take all the middlemen out, and so the money that's being made off loans is funneled right back into the government rather than going to these banks," he says.

Concerns Over Interest Rates

The government is paying private lenders more than $8 billion a year in subsidies right now. Once the shift to direct lending is complete, most of that money will go toward a $425 increase in Pell grants for the neediest students.

There's nothing wrong with that, says Sen. Lamar Alexander of Tennessee, a former U.S. secretary of education and one of the Republican leaders in Congress who opposed direct lending. If the Obama administration really wants to give students a break, though, he says, why not use those savings to cut the interest rate on student loans?

Otherwise, "this is going to cost the students about $1,700 to $1,800 in higher interest payments over 10 years on an average $25,000 loan," he says. "And when students get their loans and start going back to school in the fall, they're not going to be very happy."

Proponents of direct lending say Alexander's figures and his argument are misleading; interest rates are not going up. Under direct lending, students won't pay more than the fixed rate set by Congress — 6.8 percent.

The switch to direct lending is a done deal — and not just because Congress passed it. As Gregory observes, before private lenders and banks were pushed out, many had pulled out on their own.

"I think we're to the point now that trying to do student loans through the banks is too risky for us as a school," she says. "I need to go with something stable."

Montgomery College has already processed its first 80 direct student loans without a glitch. By July 1, all 5,500 colleges in the federal student loan program will have to do the same — whether they want to or not.

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