WASHINGTON – Congress on Friday approved the largest overhaul of education funding in 60 years, slashing subsidies to lenders by $20.9 billion over five years and redirecting the funds to boost financial aid to students and reduce interest payments on their loans.

The bill would offer debt forgiveness for students who enter certain public sector jobs and invest $510 million in minority colleges. It would have particular meaning in California, which has more recipients of low-income student grants than any other state. The bill’s increases in those Pell Grants are expected to benefit roughly 5.5 million needy students nationwide.

Democrats hailed the legislation, describing it as the largest college aid package since the 1944 GI Bill and a boon to families at a time of skyrocketing college costs. But lenders warned that the bill would drive smaller financiers out of business, leaving students with fewer and less attractive loan options. And Republicans claimed that it would burden taxpayers with costly new entitlement programs.

Despite GOP opposition, President Bush indicated Thursday that he would rescind an earlier threat to veto the bill and sign it into law.

Passage of the College Cost Reduction and Access Act comes at a time when college costs have soared nearly 40 percent in the p ast five years. It also coincides with increased scrutiny of the $85 billion student-loan industry, which has been shaken by recent scandals involving conflicts of interest among lenders and school officials, as well as kickback schemes.

Democrats campaigning to retake control of Congress in January focused on the issue, with House Speaker Nancy Pelosi, D-Calif., declaring that cutting student loan interest rates in half would be one of her party’s top priorities.

On Friday, one of the bill’s sponsors, Rep. George Miller, D-Calif., described the bill’s passage as a victory for middle-class families. “This bill takes extraordinary steps to bring urgently needed financial relief to students and families who are working very hard to pay for college,” he said.

The leading Republican on the House Budget Committee, Rep. Paul D. Ryan of Wisconsin, said Democrats were not being upfront about the bill’s cost to taxpayers.

“This is a cynical attempt to make good on a campaign promise,” Ryan said, predicting the interest rate cuts, now temporary, would be extended. If that happens, Ryan said, over 10 years “W e’ll see another 20 to $30 billion blow out the door.”

Gabriel Pendas, president of the United States Student Association , a group that represents 1.3 million students, called the bill a “good first effort.” Pendas, who graduated last year from Florida State University with a degree in physics and $45,000 in debt that he expects to “be paying my whole life,” said Congress needs to tackle the underlying problem: rising tuition. “A lot of folks are being priced out of college,” he said.

The bill would halve interest rates for students starting July 1, from a current 6.8 percent to 3.4 percent phased in over four years. Those rates reverse an increase that the previous Republican-led Congress allowed as a way to fund tax cuts. The lower rates would expire after five years unless Congress renews them.

At the beginning of the 2008-2009 academic year, the bill would begin increasing the maximum Pell Grant from $4,300 to $5,400 by 2012. In the 2005-2006 school year, 584,580 California students received those grants.

Students with direct loans from the government would receive debt forgiveness after 10 years of work in certain public sectors, including emergency first-responders, nurses, firefighters, prosecutors, early childhood educators and librarians. That provision takes effect July 1. Undergraduates who commit to teaching in high-need public schools would receive upfront tuition assistance of $4,000 a year, to as much as $16,000, starting from the 2008-2009 academic year.

From July 1, 2009, onward, the bill would cap students’ monthly federal loan repayments to 15 percent of what the government determines to be their discretionary income. It would also funnel $285 million toward Upward Bound, a program that prepares needy students, or those whose parents did not receive higher education, to go to college.

Patrick Callan, president of the National Center for Public Policy and Higher Education in San Jose, Calif., described the bill as a “response to the large, building public anxiety about the cost of college.”

Callan said that since the early 1980s, family income increased 170 percent, inflation rose 95 percent, the cost of health care climbed 225 percent and the price of a college education soared 375 percent.

“This bill restores the principle of educational opportunity without having it depend on your financial resources,” Callan said. He noted that the bill particularly helps states like California, with a rising generation of elementary school children who are “heavily low-income, first-generation students.”

Jamie Merisotis, president of the Institute for Higher Education Policy in Washington, D.C., praised the investment in institutions serving black, Hispanic and American Indian students. “That will be a big help, given the demographic trajectory of the country,” he said.

Miller and co-sponsor Sen. Edward M. Kennedy, D-Mass., who lead their chamber’s education committees, stressed that the bill’s programs would be fully covered by the $20.9 billion in cuts to lender subsidies over five years.

Those cuts target the subsidies loan companies receive from the federal government for lending to students. The subsidies are meant to offer some security for extending loans to students who have no income, sometimes no co-signer and usually no collateral.

A few lenders, including SLM Corp., known as Sallie Mae; Student Loan Corp.; and Nelnet Inc. dominate the industry, but more than 3,500 lenders provide, service and finance federally guaranteed student loans.

Kevin Bruns, executive director of America’s Student Loan Providers, argues that by shaving the subsidy for for-profit companies by 0.55 percent, the bill narrows lender profits to the point that they would have no return. He predicted that smaller lenders will shut their doors, white larger lenders will take over, leading to fewer choices.

“Six million borrowers will feel that,” Bruns said. “The taxpayers are going to hurt.”