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How State Financial Aid Organizations Work

Student Loan Guaranty Agencies

Students can receive direct loans or Federal Family Education Loans (FFEL) loans from the government. Direct loans are paid directly from the government. FFEL loans are paid through private lenders.

On the other hand, state-based guaranty agencies (also known as "guarantee agencies" or "guarantors") act as middlemen between the federal government, private FFEL lenders and student borrowers. Guaranty agencies are neither federal nor state government entities. Like higher education assistance agencies, guaranty agencies are private nonprofits. In fact, many higher education assistance agencies double as guaranty agencies.

The role of the guaranty agency is to reach out and educate state high school and college students about the availability of financial aid. The agency often reviews and processes loan applications to take the burden off the private lenders, and it even helps disburse the loan funds directly to the college or university [source: America's Student Loan Providers]. However, the main responsibility of the guaranty agency is to pay private lenders if student borrowers default on their loans.

If a borrower defaults on a student loan, the private lender can file a default claim with the guaranty agency, which has to purchase the balance of the loan. The federal government will reimburse the state guarantee agency, but only up to 95 percent of the purchase amount. And that's only if the feds determine that the guaranty agency did everything in its power to prevent the default. The actual reimbursement amount can be as low as 75 percent [source: America's Student Loan Providers].

Since guaranty agencies are reimbursed according to their due diligence in helping students avoid default, agencies expend a lot of effort educating and counseling borrowers about managing their loan payments. Even after a guaranty agency is reimbursed, the agency still has the responsibility of collecting on the defaulted loan. It can either work through other state agencies (the Department of Motor Vehicles or state tax office) or through private collection agencies [source: America's Student Loan Providers]. The goal is to get the borrower onto a default rehabilitation program to repay the debt on more reasonable terms.

Most federal student loans come with a "guarantee fee" of 1 percent or less of the disbursed amount. That fee compensates the state guaranty agency for its work.

In states like Pennsylvania, where the guaranty agency handles a large volume of loans -- more than $84 billion at last count -- the agency waives the guarantee fee for borrowers [source: FinAid].

Now let's look at how the treasury helps families pay for college.