Big Changes in Federal Student Loans

On July 1, 2006, Congress made big changes to the Federal student loan program. While many of these changes won't affect federal loans taken out prior to July 1, 2006, one major change will affect current federal borrowers, particularly high-balance medical, law and business school borrowers graduating after July 1, 2006.

On July 1, 2006, Congress decided to increase interest rates dramatically. Prior to 2006, the Federal student loan program was designed to encourage low income students to attend college. That seems to be a passing phase. Federal student loan borrowers can saw the interest rates on their loans to jump 30% on July 1, 2006, after the government completed its annual resetting of student loan rates.

Stafford loans are variable rate loans and the government resets the interest rate on those loans every July based on market interest rates. The benchmark interest rate used by the government, the 91-day Treasury bill rate, has risen approximately 30% since July 2005 and the Federal Reserve pushed those rates even higher.

One way students avoided paying more on their loans was to consolidate under the Federal Student Loan Consolidation Program prior to July 1, 2006. By consolidating prior to July 1, 2006, students locked in a single, historically-low fixed rate on their loans.

Congress also eliminated the "in-school" consolidation option for students on July 1, 2006. Historically, students generally had to graduate before they could consolidate their loans under the federal program. However, in the past year the U.S. Department of Education has confirmed that continuing students are eligible to consolidate their loans while still in school.

Just as with a typical consolidation loan, repayment on an "in-school" consolidation loan did not begin until after the borrower leaves school, but "in-school" consolidation did require the borrower to waive the six-month "grace period" following school, during which time no payments are required. As a result, the loans consolidated never entered immediate repayment, unless the borrower applied for a deferment or forbearance of the loan payments.

During periods of deferment or forbearance a borrower is not required to make payments on the loan. During deferment, the federal government continues to pay the interest on the subsidized portion of the consolidation loan, while during forbearance interest accumulates on both the subsidized and unsubsidized portions of the consolidation loan.

Unfortunately, in school students can no longer take advantage of low rates by consolidating their student loans. Thanks to Congress, interest rates have risen so dramatically and so quickly that many high school students and their parents no longer view or trust federal student loan programs. The ramification of Congress’ decision may be long-term and irreparable.