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Student Loan Programs: New Rules

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Federal Financial Aid

In 2006, the $85 billion-a-year student loan industry became the target of an investigation by New York Attorney General Andrew Cuomo, who found widespread corruption in relationships between many student loan lenders, university officials, and the U.S. Department of Education. The scandal has prompted the U.S. Department of Education to issue new rules for the management of its federal student loan financing programs.

At the center of the storm are colleges and college officials who received perks, benefits, cash, and gifts from "preferred" lenders in exchange for sending students to them for their student loans - a clear conflict of interest. Top officers in financial aid departments at several schools as well as the U.S. Department of Education have resigned or been fired or suspended due to the student loan scandal.

The U.S. Secretary of Education, Margaret Spellings, and her deputies came under fire from the New York attorney general, Andrew M. Cuomo, who is heading the investigation into the deceptive college student loan practices. According to Mr. Cuomo, they had been "asleep at the switch."

Now, the Department has proposed a number of changes to the rules that govern the way federal student loans are offered and awarded. The new rules are much more strict and may help to cut down on these quid pro quo relationships.

One new rule requires colleges to include at least three lenders that are not affiliated with the school on their "preferred" lender lists, and to give students information they can use to compare preferred lenders for their student loans. Further, college must guarantee that any benefits offered by the lender must apply to all students, including students considered a greater credit risk.

Under the new regulations, colleges will also be required to tell students how and why the schools came to choose the lenders they suggest for student loans. Students will be reassured that they have a choice in lenders and are not obligated to choose one from the list the school provided.

And very importantly, colleges will not be allowed to particularly recommend lenders that offered any sort of payment to the college in return for a place on the school's "preferred" lender list.

The new restrictions also provide a clear list of what lenders can and cannot offer colleges in exchange for having students steered directly to them for student loans or for being put on a "preferred" lender list. Gifts and kickbacks now banned include items such as cash or prizes; lavish, all-expense-paid trips to resorts or other entertainment expenses; computer systems; conference registration, transportation, and lodging costs; stock options; and arrangements that allow college officials to sit on advisory boards of loan companies.

However, the proposed regulations still allow lenders to offer some incentives. These potential loopholes resulted in dissatisfied responses from consumer and student advocates, along with the New York Attorney General himself. A written statement from Mr. Cuomo said that "a gaping hole" in the regulations still created an unfair situation for student borrowers looking for student loans.

U.S. Senator Edward M. Kennedy (D-MA), senior Democrat of the Senate Health, Education, Labor and Pensions Committee, thought the proposals were a "positive development." But he also hinted that his committee would likely keep a closer eye on ethics in the student loan industry. Both the U.S. Senate and House of Representatives passed student loan legislation in February.

Lenders were mostly pleased with the new rules. The special counsel to the Consumer Bankers Association said that lender had accepted "the inevitability of reform."

The new proposals are most likely to be in effect in the summer of 2008, following a standard 60-day period of public feedback. In the meantime, 24 colleges and universities and several lenders have signed written agreements to observe a code of conduct created by Attorney General Cuomo.

Sources: 1) "Education Dept. Proposes New Rules for Student-Loan Programs to Crack Down on Abuses," by Kelly Field. The Chronicle of Higher Education, Online, 6/4/2007. 2) "Another subprime scandal," The Economist, April 12, 2007.

Sarah Durning is a content contributor for CourseAdvisor.