Debt Deal Limits Student Loan Cuts

NEW YORK ( TheStreet) -- Education advocates cheered the debt ceiling deal for preserving funding for low-income undergraduate students and were mostly relieved that the cuts weren't as bad as expected.

The deal eliminates the interest subsidy on federal loans for students in graduate and professional programs. Currently, such students are not charged interest on the loan while in school and during grace and deferment periods.

The proposal also does away with some incentives that encourage on-time repayment of federal loans. Under the proposal, students will no longer receive a partial rebate on their origination fee.

Under current law for the partial rebate, borrowers initially pay only 0.5 percent of the 1-percent borrower origination fee on subsidized and unsubsidized loans. If a borrower makes 12 on-time payments in the first year of repayment, the Secretary of Education will forgive the additional 0.5 percent of the origination fee.

The two changes to the Federal student loan program will generate nearly $22 billion in savings over a ten year period beginning July 1, 2012, when the new rules take effect. Of the savings, at least $17 billion will go towards funding the Federal Pell Grants - which awards a maximum of $5,550 to undergraduate students who are financially needy.

According to Sandy Baum, , a consultant to not-for-profit organization College Board , policymakers made the right decision in eliminating interest subsidies for graduate students because the program was "not directed at students who need the help the most."

"The elimination of the in-school subsidy does not make funding unavailable to graduate students," said Baum. "Right now only a small fraction of their loans is subsidized. Graduate students will owe only a little more when they graduate. It is much more important that we preserve Pell Grants which helps low-income students."

The changes to the program does not make graduate school impossible to attend, she said. It would likely affect students who are in graduate school longer- those in medical school, for instance- than those who attend programs that just last a year or two.

The CBO estimates that approximately $125 billion in loan volume from the subsidized to the unsubsidized loan program.

Still, that may not give private lenders such as Sallie Mae ( SLM) or Discover Financial ( DFS) or any of the bank lenders any advantage. "Maybe students will think Federal Loans are not so great anymore but these programs still carry a fixed and legislated interest rate and they have repayment protection."

"Compared to what they could have done to student aid, this is not bad," she added.

--Written by Shanthi Bharatwaj in New York

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