Recent legislative changes to government student loan programs might open doors for more borrowers, but they could also increase the likelihood of borrower defaults, said Fitch Ratings last week.
On March 30, the House of Representatives passed the College Access and Opportunity Act of 2006, which rolls back the single-holder rule for consolidated loans, after July 1, 2006. The current single-holder rule requires a borrower to consolidate all of their outstanding loans with the lender that holds them, even if they could get a better deal elsewhere. The new rule says that student loan borrowers can shop around for the best deal, and consolidate all of their loans with one lender.
Two days later, President Bush signed legislation that reauthorized the Higher Education Act and its programs, extending them through September 30, 2006. The PLUS program under Federal Family Education Loan Program (FFELP) also underwent changes. Previously limited to undergraduates, the program will be open to graduate and professional students starting July 1. In addition, the interest rate will switch to a fixed 7.9% from a floating 3.1% spread over the 91-day T-Bills. Under the Higher Education Reconciliation Act of 2005 (HERA), meanwhile, interest rates on PLUS loans would change to 8.5% after July 1.
While these changes make a post-secondary education accessible to more students, Fitch says it "expects the increase in Stafford loan limits and graduate borrowers' first-time access to PLUS loans to result in higher average borrower indebtedness across the board for all student loan types." The changes especially appeal to individuals who might have dismissed graduate school as too expensive. As for those who might have paid for graduate school with private student loans or other forms of credit, the changes might prompt them to compare the costs between using PLUS and private loans.
Because private student loans are generally priced based on risk, many deals are underwritten to a minimum credit standard. The average borrower interest rates equal 4% to 5% over Libor, or .5% to 1.5% over the prime rate. In today's environment, says Fitch, the private student loan interest rates range from 8.25% to 10%, which is on par with, or higher than, fixed rates under the Direct Loan Program and the FFELP PLUS programs.
"Graduate students may be inclined to utilize PLUS loans to pay for their education costs, as they may want to lock in a fixed rate and not be exposed to potentially rising rate," according to Fitch. Fitch said it expects default probabilities to increase for PLUS loan originations.
Before HERA passed, consolidation loans allowed borrowers to extend their loan terms and lock in a fixed interest rate calculated as a weighted average of the interest rates on their underlying loans. However, if one lender held all the loans, the borrower could not consolidate the loans with another lender.
As the borrower rate will become fixed for Stafford loans extended after July 1, 2006, the incentive to consolidate will rest on the borrower's ability to extend the loan term. A borrower with a $60,000 loan at the new Stafford loan fixed rate of 6.8%, who chooses to consolidate the loan and extend the term from 10 years to 30 years, can decrease payments by 43%, says Fitch.
Consolidation will continue to attract high-balance borrowers, but Fitch said it expects only a temporary slowdown in prepayment rates until borrowers enter the repayment phase.
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