Education & Workforce Development and Government

IU-Bloomington, IUPUI ditch private-sector lenders: Student loan turmoil spurs schools to tap federal funds

April 28, 2008

With turmoil in student lending markets escalating, some universities are making major changes to ensure students have access to loans for the upcoming academic year.

The answer for the Bloomington campus of Indiana University and for IUPUI is to return to getting loans straight from the federal government under the Direct Loan Program. The change will go into effect at the start of the next academic year.

The two universities here are following other schools across the country making the same shift away from private lenders issuing federally backed loans, such as Virginia-based Sallie Mae.

This year, more than 50 lenders that participate in the program, the Federal Family Education Loan Program, have announced they will stop making such loans because of subsidy cuts and difficulty raising capital by selling securities backed by the loans. Sallie Mae, which employs more than 3,000 in central Indiana, recently reported that it lost more than $100 million in the first quarter and isn't able to make profitable loans at this time.

IU and many other schools were using the Direct Loan Program before 2004, when Sallie Mae and other loan providers began undercutting the federal program by using government subsidies to offer lower rates to students and schools.

In 2005, Congress cut those subsidies, and did so again last year. In between those rounds of cuts, the New York Attorney General's Office began investigating cozy relationships between lenders and schools that had the potential to create conflicts of interest. Some lenders, for instance, provided staff to schools and paid for trips for financial-aid officers. In April 2007, Sallie Mae, one of the companies targeted, agreed to a $2 million settlement.

Then more trouble hit. The subprime mortgage market imploded, which escalated into a broader credit crunch that spawned an exodus from the student loan market. The number of lenders in that niche had topped 2,000, but now is declining almost daily.

That means there's less cash for students and the money that's available will come with higher interest rates and/or fees.

"Our goal all along was to provide the best service we could to students and families," said Roger Thompson, vice provost for enrollment management at IU. "Given all the market indicators we were seeing both in the lending community and discussions in Washington, D.C., it sort of appeared the FFELP was going."

Students will have access to the same federally backed loans they could get before, though borrowers now will be charged a fee of 0.5 percent of the loan amount. Students were not charged a fee with Sallie Mae, but the student loan giant has told IU and other schools it would begin charging a 1-percent processing fee in the fall.

"We surveyed the market and were constantly looking at options," Thompson said. "No one had zero fees, so it seemed this option is the best."

Plus, timing became an issue.

"Students are needing to know what to do now," Thompson said.

Purdue University is opting to stay with its current student loan arrangements in part because it is changing over the systems it uses for financial aid, registration, and other administrative and student services.

"We have our hands full now, so this wouldn't be ideal timing for us to make the switch," said Joyce Hall, executive director of the Division of Financial Aid at Purdue. Those opposed to the federal Direct Loan Program say schools opting back into it don't know what they're getting themselves into.

Through regulation, the federal government already has sweeping control over higher education. Critics suggest that using the government for student loans, as well, eventually could threaten universities' independence, giving them less freedom to make their own decisions on financial matters, such as how much they charge for loans.

"The more control by the government over loaning money, the more it has a say in what it charges for its services," said Steve Clinton, president of Indiana Secondary Market for Educations Loans Inc., a local not-for-profit that buys student loans from banks.

ISM has been hit hard with the credit crunch. It has $1.8 billion of loans on its books, but has been unable to raise capital to buy more loans.

"This is an unprecedented liquidity crisis," he said. "I've never seen it so tight as it is now."

Since the beginning of March, more than 130 schools have applied to join the federal program, bringing the number of schools using it to more than 1,500, about a quarter of the number that use the FFEL Program.

"I don't have a crystal ball, but I tend to think we'll see more people moving in this direction," Thompson said. "It was a business and service decision; it's just that simple."
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