New student lending rules that go into effect on July 1, 2010 will bar private banks from issuing federally-subsidized student loans and make the Federal government will be the sole source provider for low-cost Stafford loans.

In cutting out middle man, Congress has acted to save the taxpayers money and direct the money that otherwise would go to companies like Sallie Mae back into the pockets of students in the form of more grants and other aid. That’s good news.

Unfortunately this will mean the students will also have dramatically fewer choices for getting college money moving forward. With many banks having already scaled back their student loans due to the credit crisis, this move by the Obama administration will just about signal the death knell for low-cost student loans from the private sector.

With one interesting exception.

Just like peer-to-peer lending sites like Prosper.com and Lending Club allow individuals to borrow from other individuals at rates that are typically much lower than the unsecured loan rates offered by banks, a company called People Capital now offers a peer-to-peer lending platform where students are matched with college funding sources — be they individual investors, philanthropic/affinity groups or even financial institutions.

This should be especially attractive to undergraduates who can solicit their parents, grandparents, aunts, uncles and family friends to help put them through school while still getting their money back with interest.

Who can turn down a fresh-faced freshman asking for a little helping hand?

However there are stipulations. To borrow money through People Capital an applicant must:

• Be enrolled at least half time and pursuing a degree at a Title IV-eligible US educational institution.
• Be both a citizen and a resident of the United States.
• Have a valid Social Security number.
• Be at least eighteen and the age of majority in your state of residence which must be a state in which People Capital is currently lending. Despite this being an online service, each state much grant a charter for People Capital to make loans.

Like other P2P sites, investors bid on loans to fund in an auction process, and the lender offering the lowest interest rate wins funding of the loan.  Money from the lender’s People Capital account is then sent to student’s college.

Also noteworthy is the high barrier to participate as a lender in this forum.  Currently, all People Capital lenders must be accredited investors as defined under Rule 501 of Regulation D promulgated under the Securities Act of 1933. This basically limits investors to high net-worth individuals, banks, retirement funds and other heavy hitters.

This is very different from other sites where $25 or so gets you into the lending game.

I am a big fan of P2P lending and think that this could be an excellent funding source when all Federal financial aid, scholarships and grants have been exhausted. Always go for the cheap money first, but a cost-effective way to get a college degree is nothing to shake a stick at.