The federal government makes billions of dollars a year charging students and parents fees to borrow money for college, but a group of financial aid officers say those loan origination fees are a burdensome tax on families that Congress needs to end.
“This does not make sense in a federal loan program,” said Justin Draeger, president of the National Association of Student Financial Aid Administrators. “It makes sense with commercial loans because the fee covers the cost of processing the loan. That’s moot when you’re talking about a federal loan, where eligibility is determined by law. . . . Colleges are certifying the application and the federal government is just disbursing the funds.”
The association on Monday released a policy paper examining what it calls the “hidden student loan tax.” Instead of charging fees upfront, the Department of Education subtracts the money directly from the loan amount before distributing the funds. Borrowers, nevertheless, must repay the entire loan amount, plus interest. Those fees amount to 1.06 percent of the total borrowed by an undergraduate student, and 4.2 percent for parents and graduate students.
If a freshman borrows $4,124 — the average amount issued to students — the department withholds $43.96 as the origination fee but expects the student to repay the full amount of $4,124, plus interest. If parents of that freshman or if an older sibling pursuing a doctoral degree turned to the federal government for a loan of $23,986, that would translate into a $1,022.76 origination fee.
Because interest accrues on those fees, the association estimates that an undergraduate borrower in a four-year program will pay about $235 on $166 in origination charges if enrolled in a standard 10-year repayment plan. Meanwhile, the average graduate student in a two-year program will face about $1,145 in fees and interest if repaying over 10 years.
Student loan origination fees generated $1.6 billion in revenue for the federal government in the 2016-2017 award year, and $8.1 billion over the past five years, according to the paper. Parent Plus loans, one of four types of loans, account for 29 percent of all origination fee revenue — the biggest category.
In response to the high fees associated with the Parent Plus program, private lenders such as Sallie Mae and Citizens Bank have promoted their education loans as an alternative. Neither charges origination fees and they both offer borrowers who have good credit histories interest rates that are often lower than what the federal government charges. The federal government still has an edge because its loans are only offered at fixed rates, and parents aren’t required to have impeccable credit to qualify for the lowest rate.
Origination fees started out as a way to defray the operating costs of the old bank-based federal student loan program, known as the Federal Family Education Loan Program. Under that system, private lenders used their own money to finance federal loans, but behind the scenes, the government paid a portion of the interest to make the debt more affordable. And to entice lenders, the government guaranteed the debt, taking on the risk of default.
The Obama administration overhauled the system in 2010 by having only the government lend directly to students — rather than working through banks to issue the loans, but origination fees remained.
“Since we’ve moved to 100 percent federal lending, the origination fees don’t make any philosophical sense,” Draeger said. “It’s really just about balancing the budget.”
The fee structure, he said, is confusing to students and cumbersome for financial aid administrators. Origination fees are adjusted every year around October, the beginning of the new fiscal year, not in July, the start of the student aid award year. That means colleges and universities must change fees in the middle of fall enrollment. And when the rate changes, a school must cancel all loans that are awaiting disbursement and re-award the money with the new origination fee.
Draeger said now is the perfect time to consider eliminating origination fees as a part of a broader overhaul of the federal student loan program. Congress is due to reauthorize the Higher Education Act, which governs financial aid, and lawmakers have signaled a desire to simplify the entire federal aid system.
Sen. Lamar Alexander (R-Tenn.), chairman of the Senate education committee, has long called for one federal loan and one federal grant program, instead of the multitude of options that now exists. Alexander could not be reached for comment on his position on the elimination of origination fees. In the House, Rep. Susan Davis (D-Calif.), the ranking member of the higher education subcommittee, re-introduced legislation this September that would end federal origination fees.
“Getting rid of origination fees fits into the simplification conversation,” Draeger said. “If we’re going to hit reset on student loans, this should be at the forefront of that conversation.”