Health care wasn’t the only reform enacted by lawmakers recently. The $940 billion health care reform overhaul also brought dramatic changes to financial aid that will permanently alter the student lending market. The law eliminates the Federal Family Education Loan Program (otherwise known as FFELP) and redirects more funds into the federal Pell Grant program. While the changes will provide a much-needed boost to low-income students, they could reduce loan options for middle-income students, critics say. Here’s what the bill means for tomorrow’s college students.

No middle man, bigger Pell Grants

Instead of hiring private institutions to originate federal loans, the government will now do it directly. This will save the taxpayer an estimated $61 billion over the next 10 years, reports the Congressional Budget Office.

The savings will be split, with $9 billion directed to reducing the national deficit and about $36 billion going to increase the Pell Grant program, which targets students from the lowest-income households. While such an increase seems like a major boost to the program, Mark Kantrowitz, publisher of the financial aid Web site, says that most of those funds will be used to simply keep the Pell Grant at its current level.

“Since the government underestimated how many people would qualify for the Pell Grant, about $19 billion of the money will be spent on paying off a current deficit in the program,” says Kantrowitz. “The rest will go to increasing the Pell Grant, but at a rather anemic rate.”

In the short-term, a portion of the funds will go to maintaining the current Pell Grant level of $5,550 per year, an amount which was slated to decrease at the end of this year. Beginning in 2013, the Pell Grant will steadily increase 1 percent to 2 percent each year over the next five years, up to a maximum annual amount of $5,975. The problem, says Kantrowitz, is that the planned increases will be far outpaced by the average rate of tuition, which rises 8 percent each year, according to, making the Pell Grant slightly less valuable over time relative to the price of college.

Lower rates for PLUS loans

The elimination of FFELP will also reduce the interest rate on federal parent PLUS loans and graduate PLUS loans, explains Lauren Asher, president of the Berkeley, California-based think tank, the Institute for College Access and Success. Currently schools administer these loans under one of two programs, the FFELP program, which comes with a slightly higher PLUS loan interest rate, or the Direct Loan lending program, which incurs a slightly lower one.

“Under the current system, schools, not students, decide which loan program to participate in, which means parents and students were paying 8.5 percent if their schools used FFELP while those at Direct Loan schools paid 7.9 percent,” says Asher. “Now, everyone will pay the lower rate.”

Critics argue that the savings gained by eliminating FFELP will be tempered by a significant reduction in the number of private lending institutions willing to make student loans. Because banks make the majority of their money originating federal loans, the absence of those funds could cause many banks to pull out of the student lending market entirely, dramatically reducing the available options for students in need of private loans.

“We’ve already seen a lot of the largest players getting out and the market is definitely going to get a lot smaller,” says Kantrowitz. “More smaller lenders could start making student loans, but it could be harder to get a (private) student loan in the future than it is now.”

Other improvements

Students of the future will also have better terms on their federal student loan repayment plan. Beginning in 2014, new students enrolled in income-based repayment (a relatively new option) will have their monthly student loan bills capped at 10 percent of their discretionary income (which is still defined as any income above 150 percent of the poverty line) rather than the current 15 percent rate. The new legislation will also shorten the forgiveness time on loans in the federal income-based repayment plan from forgiveness after 25 years of consecutive payments to 20. Because the provisions aren’t retroactive, they will only affect new borrowers taking out new loans after 2014.

The new legislation also allocates approximately $2 billion in grants to community colleges, $750 million to the College Access and Completion Innovation Fund, which provides need-based grants for low-income two-year college students, and $2.6 billion for historically black colleges and universities.

“For students and families, this is all good news,” says Asher.