Discover How Student Loan Origination Fees Work

 Allesandra Lanza

The nation's college financial aid officers are once again calling for the elimination of origination fees, often referred to as a hidden tax on federal student loans. Origination fees – the cost the government collects when a student loan is issued – don't receive a lot of attention in the national conversation on student debt.

Many borrowers might not even realize their federal student loan has this fee, unless they read the fine print of their promissory note. That's because the government deducts the origination fee before disbursing the loan directly to the school to cover tuition and fees.Federal student loan borrowers are responsible for repaying the entire amount of their loan plus interest, including the origination fee. For most undergraduates, the fee doesn't impose much of a burden.

According to a recent National Association of Student Financial Aid Administrators issue brief, an undergraduate borrower who took out the average amount of federal student loans for the past four years and repays them over the next 10 years will pay an additional $235 in fees and associated interest. That amount rises to $338 if the loan repayment term stretches to 25 years.

For parents and graduate students, though, the origination fee is more costly, which we'll take a closer look at below.

History of Origination Fees

The origination fee on federal Stafford loans began when private lenders issued these loans and the federal government backed them. To encourage private lenders to make low-interest loans to students with no income and no credit history, the government offered subsidies to the lenders.

To help offset the cost of those subsidies, the government charged the borrower an origination fee that was based on a percentage of the approved loan amount. The Higher Education Act specifies a 1percent fee for Stafford loans and a 4 percent fee on PLUS loans.

Since 2010, however, the federal government has directly funded all federal Stafford and PLUS loans, with no subsidies needed for private lenders. Yet the origination fees have stayed in place.

In 2011, the Budget Control Act put in place sequestration, which is a tool used to automatically reduce the national deficit, until 2021. Under the terms of the sequestration, the budget for the student loan program is essentially cut by raising the origination fee.

For the current federal fiscal year of Oct. 1, 2017, through Sept. 30, 2018, Stafford loans have an origination fee of 1.066 percent of the loan amount, while PLUS loans have an origination fee of 4.264 percent.

Case Against Origination Fees

Critics of the origination fee, like NASFAA, contend that it's unnecessary and outdated and is being used today primarily to generate revenue for the government.

Although the fee is small for undergraduate borrowers, it has translated to $1.6 billion in revenue in 2016-17 and $8.1 billion over the past five academic years. Parents and graduate students have generated most of that money, since PLUS loan origination fees are substantially higher than the Stafford fees.

In fact, parent PLUS borrowers collectively paid more than $2 billion in origination fees over the past five academic years – more than any other borrower type. And as previously mentioned, the cost of the origination fee – especially for parents and graduate students – can increase over the life of the loan.

The NASFAA issue brief found that the average graduate student was charged $709 in origination fees over the past two academic years and will repay $1,145 in fees and associated interest over the next 10 years, or $1,800 if paid over 25 years.

For graduate students facing a possible tax hike on tuition waivers, extra costs like the origination fee can put higher education further out of reach.

Meanwhile, parents who are put off by the federal PLUS loan fee may turn to no-fee private loans instead; but these loans don't offer the same consumer protections as the federal offerings. And even undergraduate borrowers, who face the least burden from the origination fee, may soon be looking for any cost savings they can find for their student loans if Congress abolishes the student loan interest tax deduction.

Some higher education institutions also complain that origination fees cost them time and resources. Because origination fees change on Oct. 1 in alignment with the federal fiscal year, rather than the traditional academic year, schools have to adjust the fees in the middle of the fall semester. That means a school typically has to cancel all the loans not yet disbursed and redo them with the updated origination fees.

So what are the chances the origination fee is done away with? It's hard to say, given that it is a moneymaker in the national budget.

But with both the House and Senate education committees seemingly committed to reauthorizing the Higher Education Act in the very near future, and bipartisan support for decreasing complexity in federal student aid, perhaps there's hope for fee-free federal education loans in the future.

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Allesandra Lanza
05 March, 2018
Allesandra Lanza
19 November, 2017