WASHINGTON (CNNMoney.com) -- The House voted 220-211 on Sunday to make Washington the one-stop-shop for cheap student loans and to boost funding for need-based scholarships.
While approving the overhaul of health care, the House also voted along party lines on another of President Obama's top priorities: cutting out bank middlemen who collect subsidies to make education loans guaranteed by the federal government.
"Tonight's vote in the House is an important first step towards a big victory for America's students," Secretary of Education Arne Duncan said in a statement.
The proposal was included in the so-called reconciliation bill before the House. The Senate will take up the bill in coming days.
Under the plan, nearly all federally-backed student loans, like Stafford loans, would come straight from the government. The new system would start in July and the government would make approximately $500 billion in direct loans loans in the first 10 years, according to a Congressional Budget Office estimate.
"With this one move, we can make college more affordable, keep jobs in America, prepare young people for our global economy and reduce our deficit by billions," said Rep. George Miller, D-Calif., chairman of the House Education and Labor Committee in prepare remarks.
The stakes are high. Private loans backed by the federal government are the single most common way students finance higher education.
In the current school year, banks issued some $67 billion in federally-backed student loans, while the government directly lent $30 billion, according to the Department of Education.
One of the private-sector lenders with the most on the line is Sallie Mae, which also sells students its own loans at higher interest rates. It has argued that the legislation could cost private banking industry jobs.
"This is not the final chapter," said Kevin Bruns, executive director for America's Student Loan Providers, a lobbying group for lenders. "The Senate now has the historic opportunity to pass health reform without eliminating thousands of jobs and critical student services."
Yet, congressional watchers expect the student loan legislation to pass the Senate.
"This is bad for Sallie Mae, as it will now be out of the origination business," said Teddy Downey, a policy analyst with Concept Capital Washington Research. "Our view that there is zero chance for student lenders to stay in that business."
The measure, which has been the subject of a bitter lobbying battle between the administration and the industry, would save the federal budget $61 billion over ten years. Of that amount, $36 billion would be directed to the popular Pell grant program, which is facing a historic shortfall due to record numbers of Americans who went back to school.
If the proposal passes, private companies will no longer be able to make federally backed loans.
The move would save federal money by ending subsidies banks get to make the loans and by allowing the government to keep the difference between what it costs to make the loan and what borrowers are charged.
Low-income students would benefit the most. The proposal would increase maximum Pell grant awards to $5,900 by 2017, up from $5,300 now.
If nothing is done, 8 million students could face a 60% cut in funding and 600,000 students could lose their Pell grants entirely in 2011, according to the bill's supporters.
"This bill is not as good as it originally was," said Mark Kantrowitz, a financial aid expert and publisher of FinAid.org and FastWeb.com. "It is difficult to see how President Obama will be able to meet his college graduation goals by 2020."
When Obama took office, he said he wanted America to have the highest number of college graduates in the world by 2020.
As a practical matter, consumer advocates say most students seeking federal loans won't notice a difference. College financial aid offices would continue to work as intermediaries and many already administer direct government loans.
Some Republicans and the private student loan industry have opposed the legislation, arguing that the government shouldn't cut banks out of the business. They say that thousands of jobs at private lenders are at stake, including 2,500 at Sallie Mae (SLM, Fortune 500).
The foes of the legislation also say that the change will cause delays and disruptions in processing loans. They argue that the government doesn't have the manpower to take over the high volume of loans now originated by the private sector.
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