Summary: Limitations on lending by schools and prohibition on inducements to schools by lenders must be observed.
SUMMARY: Limitations on lending by schools and prohibition on
inducements to schools by lenders must be observed.
It has recently come to our attention that there may not be
sufficient awareness in the student financial assistance
community of the substantial limitations imposed by section
435(d)(2) and (5) of the Higher Education Act of 1965, as
amended. These provisions address the participation of schools
in the Federal Family Education Loan Program as lenders and the
offering of inducements by any lenders to schools or individuals
to secure loan applicants.
Congress has focused on this subject several times. One common
theme to these reviews has been the desirability of separating
the academic and lending functions when possible. Such
separation of functions is designed to prevent the student from
confusing his/her obligations as a borrower with his/her feelings
about the school and removes an economic interest that may affect
the school's objectivity as it advises the student with respect
to financial assistance. Another common theme has been the
desirability of having students' borrowing decisions made on the
merits of the loans rather than extraneous marketing incentives
to students and their schools. To deal with these concerns,
Congress restricted the activities of school/lenders in paragraph
(d)(2) and of all lenders in paragraph (d)(5).
Paragraph (d)(2) provides that in order to be an eligible lender
in FFELP, a school must, among other things, not make any loan to
a first-time undergraduate borrower unless the borrower has been
denied a loan by an eligible lender. This is an important
limitation flowing from the desirability of separating the
academic and lending functions whenever possible. It may not be
evaded by arrangements in which some other lender formally
originates the loan and holds it for a short period of time, but
the arrangements between that lender and the school allocate all
but a small portion of the lender's economic risk and profit to
the school. In determining whether a school has complied with
paragraph (d)(2), the Secretary will look at the substance of the
arrangements rather than merely at their form.
Paragraph (d)(5) excludes from eligible status any lender that
offers, directly or indirectly, any "inducement" to a school in
order to secure applicants for FFELP loans. Loan decisions by
students may affect their entire lives significantly, and such
decisions should be based on the merits of the loans and not on
extraneous factors, particularly not on monetary benefits given
to the schools on which students often rely in such matters. In
this respect it does not matter whether the lender offers the
monetary benefit to the school directly or simply arranges for
the school to receive the benefit from a third party. Here, too,
the Secretary will look at the substance of any arrangements
rather than merely at their form.
We have recently learned of a number of relationships between
non-school lenders and schools in which the non-school lenders
have arranged for the schools to be the lenders of record and
receive the interest subsidy for part or all of the in-school
period on loans later "bought" by the non-school lenders. The
actual processing of the loan origination is done by the non-
school lender in its own name or in the name of the school, and
the loan is subsequently "sold" to the non-school lender. Thus,
the school receives all the income on the loan during its most
desirable phase, when both the expense and risk of default are
the least. Often the non-school lender also provides the
financing for the school to fund its "holding" of the loan at an
Although providing "inducements" to a school is not permitted for
any lender, it becomes part of an improper activity for the
school as well when it is structured to enable a school "lender"
to evade the limitations of paragraph (d)(2) on an undergraduate
loan. We have heard of situations, for example, in which the
non-school lender itself originates the loan acting as "trustee"
for the school and subsequently "buys" the loan from the school
after the school has received substantial interest payments or in
which the non-school lender that ultimately "buys" the loan
arranges for some other "lender" to be the originator of record.
Arrangements such as these put both the school and the non-school
lender at risk of losing their eligibility under FFELP.
Congress has provided severe sanctions for conduct by an eligible
lender exceeding the limitations of paragraphs (d)(2) and (d)(5).
In addition to the general sanctions in the Higher Education Act,
paragraph (d)(5) expressly provides for the disqualification of
the lender from participation in FFELP. Although the same
procedure is not expressly provided by paragraph (d)(2), both
disqualification and the loss of benefits on the particular loans
involved could follow from a finding that a school had exceeded
the paragraph's limitations. The Department considers lender
activity exceeding these statutory limitations as extremely
serious and will not tolerate its continuance. Arrangements
designed to enable schools to evade the statutory limitations on
their lending activities or to confer a monetary benefit on them
to induce the securing of FFELP loan applicants must be ceased
We appreciate your attention to this important provision of the
Higher Education Act.
Senior Advisor to the Secretary