>My question is - is there any reasoning to the above behavior or I have 
>completly misunderstood how Freeradius conf works.

Yes. Password attribute was wrong. This was changed in 1.1.4 but 1.1.x
continued to tolerate it. It's no longer tolerated in 2.x.

You should also remove Auth-Type EAP form the user configuration.

eap.conf:

"Whatever you do, do NOT set 'Auth-Type := EAP'.  The server is smart
enough to figure this out on its own.  The most common side effect of
setting 'Auth-Type := EAP' is that the users then cannot use ANY other
authentication method."

Ivan Kalik
Kalik Informatika ISP

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