State Student Loan Programs Look to Fill Financial Aid Gap

 
Cuts to Georgia's HOPE scholarship nearly put a dent in Shondra Chester's plan to return to school this fall for a bachelor's degree. The 35-year-old single mother of two hopes that completing her degree in business administration at Mercer University in Macon will help her advance in her career working for the Secretary of State and serve as an inspiration for her two sons, particularly 14-year-old William, who wants to be an engineer.

"If momma goes back to school," she says, "that's another positive for him."

But after tapping her other sources of financial aid, Chester found that she was still short of funds for tuition, books and other school-related expenses — a gap she'd planned to fill with HOPE money. That's when she discovered a new state-sponsored program that could help make up the difference.

The Student Access Loan, offered for the first time this fall, is designed to be Georgia's aid of last resort for students who have exhausted their other federal and state options. Georgia is among six states that recently have unveiled new student-loan programs designed to help students pay for expenses beyond the amount financial aid and family support can cover.

Those new loan programs are starting just as states across the country have cut funding for higher education, which has led to higher tuition at many public colleges and universities. At the same time, many states have cut back on funding for grants and scholarships to students. Georgia's HOPE scholarship used to make in-state public school free for students who graduated from high school with a B average and kept up a 3.0 grade point average. Starting this school year , Georgia has reduced the amount of the scholarships and increased the academic requirements.

Georgia launched the new loan program in part because legislators were worried about the impact of the cuts to HOPE. The Georgia program is unique in that its initial funding comes from a $20 million legislative appropriation — most other state loan programs are funded through bond issuances. The loans come with an unusually attractive 1 percent interest rate.

"We had students who didn't want to take federal loans and wanted to take this instead," says Tracy Ireland, an executive with the Georgia Student Finance Commission. "Unfortunately, that isn't the intention of this."
state student loan interest rates

Most states that offer student loans charge interest rates of between 6 and 8 percent, much higher than Georgia's, and higher than the subsidized version of the Stafford loan — the most common type of federal financial aid — which has a 3.4 percent rate. Instead of competing with Stafford loans, the state offerings are generally comparable to the federal PLUS loan, a supplemental loan that can be taken out by the parents of undergraduate students who have exceeded their Stafford limit or by graduate students in the same position.

Some of the states offer rates that are significantly lower than PLUS. North Dakota offers the Dakota Education Alternative Loan, through its one-of-a-kind state bank, with interest rates as low as 4.88 percent for in-state students. In Texas, the interest rate on College Access Loans was lowered this year to 5.25 percent.

Changing the model

While student loans are a new business for some states, in others, it's nothing new. New Jersey's Higher Education Student Assistance Authority traces its roots to 1959 and has been offering NJCLASS loans since 1991. For the state loan agencies that have been around a while, however, the business model is changing.

That's largely because of changes in the federal student loan program that came in 2010. Before then, state loan agencies, which are nonprofit, relied heavily on issuing and servicing federal loans. Now, the federal government directly issues all new federal student loans, although some of the state loan agencies are eligible to service some of the loans.

"These organizations have been trying to reinvent themselves," says Mark Kantrowitz, a financial aid expert and publisher of the FinAid and FastWeb financial aid websites. "There's a lot of experimentation going on."

Whether agencies can succeed in reinventing themselves remains to be seen. Barbara Lambotte, a senior credit officer at Moody's Investor Service who analyzes state loan programs, says new loan offerings are always risky because of the difficulty of anticipating student demand and predicting the rate of default.

"To build a history book really takes a lot of time," she says. 'They're not going to have a sense of performance until four or five years from now."

Strings attached

The state agencies typically have lower default rates than the average for all federal loans. The federal default rate was 8.8 percent in the most recent set of data released by the U.S. Department of Education. By contrast, the default rate for loans issued by the Massachusetts Educational Financing Authority in fiscal year 2010 was 1.6 percent. The default rate for the Alaska Supplemental Education Loan in 2009 was 6 percent.
state student loans

State agencies say their default rates are lower because they do more education and outreach with students before they take out loans in the first place. For example, borrowers in New York must complete a financial literacy tutorial in order to qualify for NYHELPs loans. Students in Iowa are required to complete the online Student Loan Game Plan, an interactive game that walks them through anticipated debt and future income, before they can take out a state loan.

Because their programs are smaller than the federal loan program, state agencies say they can intervene before paying back the loan becomes a problem. "If you're even a couple days late, we mandate that you talk to someone," says Tom Graf, executive director of the Massachusetts financing authority. "We've seen it help move the needle a positive direction."

But there's another reason why state loan programs experience lower defaults than the federal program: They're pickier in giving out loans.

Most programs have stricter credit requirements than federal loans and frequently turn away a significant number of applicants. In Alaska, one-third of all current applicants failed to meet the minimum credit score requirement . In South Carolina, which also has a credit score minimum , two-thirds of students who applied for a Palmetto Assistance Loan were turned away in the most recent year for which data is available.

State loans considered private

The loan agencies are connected to states in various ways. Most are governed by boards whose membership includes state officials. In some states, they are allowed to issue tax-exempt bonds. But in the eyes of federal officials, the loans states offer students are considered private, subject to the same rules as loans offered by banks and other for-profit student lenders.

That's an important distinction. New federal regulations passed in 2009 put limits on the relationship between private lenders and the financial aid offices of universities. The rules came in response to kickbacks private lenders were offering colleges in exchange for sending borrowers their way. Being classified as private lenders limits the amount of contact that state loan agencies can have with university financial aid offices. It also impacts what the financial aid offices can tell students about the state-sponsored plans.

In practice, most colleges shy away from offering any advice on private lenders because of the new rules, says Justin Draeger, president of the National Association of Student Financial Aid Administrators. Draeger says most of the administrators he represents think of the state loan programs as better options than private loans — but they hesitate to explicitly recommend them because of the reporting requirements.

That rankles some state loan agencies.

"Being a state program, you wish you weren't subject to some of the rules," says Chuck Sanders, president and CEO of the South Carolina Student Loan Corporation. "Obviously, what we're doing is in the best interest of our [students] in South Carolina."

But that's not a given with state loan agencies, says Lauren Asher, president of the Institute for College Access and Success. "There's nothing that requires a state-sponsored loan to be any better than a private student loan," she says. "What matters are the terms of the loan, not who's issuing it."

Many state loans don't have the same flexibility in repayment options as the federal Stafford loans. And additional fees can vary widely. Some state loans have lower fees than the 4 percent origination fee for the federal PLUS loan, but not all. In New York, for example, the NYHELPs loan carries a minimum 4 percent fee for the most highly qualified borrowers who also have a co-signer — but that amount can jump to as much as 8 percent for borrowers without a co-signer and with a worse credit history.

That information on fees can be hard for borrowers to find. Pulling together reliable information about both state-sponsored loans and other private loans is something the newly created Consumer Financial Protection Bureau will be working on as part of its charge from the Dodd-Frank act of 2010.

Already, the CFPB is working with the Department of Education on creating a model financial aid form that colleges could use to give students a better sense of what aid options are available and what their loan obligations would be in the future.

"It's an alphabet soup of acronyms and we have to simplify it," says Rohit Chopra, the CFPB's student loan ombudsman. "It's hard to tell what is a loan and what is a grant, and then compare this information across schools."

But even if the state loan programs offer better terms than private alternatives, some financial aid experts question whether students should ever consider taking either. Student debt has been growing steadily: According to the Institute for College Access and Success's Project on Student Debt, the average debt for the class of 2010 is $25,250.

"Often, people who need private loans, including state loans, are borrowing too much. They're at too expensive a school," Kantrowitz says. "The time to figure out if you can afford debt is before you start incurring it."

In Georgia, that's a constant worry for Shondra Chester as her debt load grows. But while she had hoped to minimize her loans when she returned to school, she also knows that completing her bachelor's at Mercer is a necessity if she hopes to move forward in her career in state government. 
 
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