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Currently, federal student loans are issued by the U.S. Department of Education through the William D. Ford Federal Direct Loan Program. However, recent efforts by the Trump administration suggest this system may be heading toward privatization. If this change were to be implemented, borrowers would likely be trading federal protections for the possibility of better rates and terms.
Key Takeaways
- Privatizing federal student loans would most likely entail private lenders facilitating new loans that are backed by the government.
- Potential benefits of privatization include increased competition and borrowers being steered toward more lucrative fields.
- Potential drawbacks, however, include certain students being unable to secure funding and the loss of federal borrower protection.
Understanding the Potential Privatization of Student Loans
Federal student loans offer fixed interest rates and benefits like income-driven repayment (IDR) plans, forbearance, and deferment, as well as debt forgiveness. While the government issues the loans, third-party servicers, such as Mohela and Nelnet, handle the day-to-day management.
Privatizing student loans would likely require reviving the Federal Family Education Loan (FFEL) program (or instituting something similar to it). That program was discontinued in 2010 and replaced by the Federal Direct Loan Program. Under FFEL, private lenders, such as banks, credit unions, or other financial institutions, were the originators of new, government-subsidized student loans. These subsidies compensated lenders for keeping interest rates at or below federally mandated levels and protected them when borrowers defaulted on their loans.
Note
Alternatively, the government could completely (or at least partially) divest itself from originating student loans and allow the private market to take its place. These lenders would be free to set their own terms, meaning interest rates would be tailored to each borrower’s creditworthiness (rather than set by federal policy). Additionally, without government subsidies, private lenders would be the ones assuming the risk that borrowers might default.
In either case, new student borrowers would take out loans with private lenders. Meanwhile, outstanding education loans would presumably continue to be administered by the government, though it might be able to effectively privatize existing loans by selling them to private financial institutions. For any of these changes to be enacted, however, Congressional approval would be required.
Pros and Cons of Privatizing Student Loans
Pros Explained
- Increase competition: In theory, further competition in the private lending market can incentivize lenders to offer more favorable rates and terms to attract borrowers.
- Free up federal funding: As the federal government wouldn’t need to devote resources to student lending, it could put those funds toward paying down the national debt or financing grants for low-income students.
- Better return on investment (ROI): Without government subsidies, private lenders stand to lose money if borrowers default, incentivizing them to steer students toward degrees with sufficient earnings potential to eventually repay their debts.
Cons Explained
- Limit accessibility: The private market is also incentivized to deny applicants who represent a greater credit risk or are pursuing degrees with lower ROIs, including those associated with socially valuable or culturally significant fields.
- Potentially increase national debt: Private lenders would likely be unwilling to purchase the massive federal student loan portfolio, which means government guarantees or subsidies would likely be required to make it a better offer.
- Loss of federal protections: Borrowers would almost certainly lose access to IDR plans, deferment and forbearance options, and debt forgiveness, as private lenders have a greater incentive than the government to make sure loans are repaid in full.
The Bottom Line
The privatization of student loans would significantly alter how students finance higher education. While the move may mean some borrowers end up getting a better deal than they would under the current Federal Direct Loan Program, it may also restrict who’s able to attend college and leave borrowers with little recourse if they can’t repay their debts.
Such a substantial change shouldn’t be possible without approval from Congress. However, students and their families should still stay informed and keep an eye out for additional changes to the student lending system that the current administration may try to implement.
