The Battle Over Loan Consolidation

A fight over the future of a program that allows borrowers to refinance their

ALSO SEE: Federal Judge Allows Some Parts of Suit Against Sallie Mae to Proceed Colloquy: Join an online discussion on whether Congress should set new limits on the consolidation program for federal student loans.

student loans is expected to be among the fiercest student-aid battles that lawmakers will face this year.

Pressure for Congress to overhaul the consolidation program is growing, even though the program is more popular than ever. In order to lock in interest rates of about 4 percent for the life of their loans, and save thousands of dollars each, borrowers have consolidated more than $32-billion worth of loans in 2002, almost twice as much as in the previous year.

But some major lenders in the student-loan program say that the government has made it too easy for borrowers to refinance their loans. They say that loan consolidation costs the government billions of dollars in subsidies to keep the cost of loans cheaper for borrowers. That money, the lenders say, would be better spent on student-aid programs that help low-income students gain access to college.

"People are taking these loans out because it's convenient, not because they need to," says Paul Tone, senior vice president for government and industry relations at Nelnet (National Education Loan Network), a national student-loan provider that is headquartered in Nebraska. "As a result, there will be a massive amount of federal spending over time going to people who are already out of school and, over the long haul, that will reduce the government's ability to improve or increase subsidies for low-income students."

Last month, leaders of the Consumer Bankers Association announced that they would ask Congress to make loan consolidation a less attractive option for borrowers. Under the group's proposals, borrowers would no longer be able to lock in fixed interest rates for up to 30 years, as they can now. Instead, borrowers with consolidated loans would be charged the same rate as all other federal student-loan borrowers are charged in a given year. Currently, the rate varies year to year based on market conditions. Starting in 2006, the rate is scheduled to become fixed at 6.8 percent.

The proposals are being met with hostility from advocates for students, who say that the consolidation program makes repayment more manageable each year for hundreds of thousands of borrowers who are buried in debt. Also opposing the proposals are the leaders of some new companies in the student-loan industry, known as "third-party marketers," who have been competing fiercely in the loan-consolidation market with the more-established lenders, like Citibank and Sallie Mae, the country's largest financer of student loans.

This fight has become increasingly contentious as Congress prepares to renew the Higher Education Act, the law that governs most federal student-aid programs.

For the most part, college lobbyists and financial-aid administrators have remained on the sidelines of the debate. But with lawmakers looking to them for guidance while drafting the reauthorization legislation, they may not have that luxury much longer.

While some of the college groups are likely to side with the students, others may have a powerful incentive for joining forces with the Consumer Bankers Association. Gutting the loan-consolidation program could lead to big savings for the government, which lawmakers could then use to pay for some of lobbyists' top priorities for reauthorization, such as raising the limits on what students can borrow from the federal loan programs or for reducing the fees that borrowers must pay to obtain their loans.

No matter which side prevails, however, one thing is certain, says Larry Zaglaniczny, director of Congressional relations for the National Association of Student Financial Aid Administrators: "This is going to be one of the biggest issues Congress is going to have to resolve during reauthorization."

Refusing to Back Down

Congress created the loan-consolidation program in 1986 to make it easier for borrowers to repay their student loans. By consolidating multiple loans into one, borrowers can get a fixed interest rate that is based on the weighted average of the rates on the underlying loans, and repay the loan over 30 years. Such a move is extremely popular in periods of low interest rates, as has been the case for the last year.

Last spring the Bush administration, under pressure from lenders, urged Congress to change the interest rate on consolidation loans from a fixed to a variable rate, as a way to cover a budget shortfall in the Pell Grant Program. The White House withdrew the proposal just a few days after offering it, amid complaints that the plan would deny hundreds of thousands of student-loan borrowers the chance to refinance their loans at a lower interest rate and save thousands of dollars.

But the lenders are not backing down.

At the annual meeting of the Consumer Bankers Association last month, the group's leaders said they would press Congress not only to change the interest rates on consolidated loans, but also to limit the types of borrowers who could make use of the option.

Under the bankers' proposal, only borrowers who have multiple student loans from different lenders, or those who can demonstrate they would have trouble repaying their debt without consolidating, would be able to do so. Currently, there are few restrictions on which borrowers can refinance their loans.

Protecting Profits?

Lobbyists for students say that the lenders are more worried about their profits than about helping the government save money. They point out that the recent drop in interest rates on consolidation loans has been damaging to lenders' profit margins and has led some companies to consider dropping out of the program altogether.

"The lenders' agenda is to restrict the ability of students to consolidate their loans because they make less on these loans than they would otherwise," said Kate L. Rube, the higher-education adviser for the State Public Interest Research Groups.

Advocates for students say that the bankers' proposals are also designed to drive out the new competitors that have been gaining a foothold in the consolidation market. Lobbyists from the "third-party marketers," such as Collegiate Funding Services and the College Loan Corporation, agree, saying that the bankers would rather kill the loan-consolidation program than offer competitive loans to borrowers.

"The lenders' comments about consolidation being 'bad policy' are simply an attempt to mask their self-interest," says Jim Newell, vice president of government relations for Collegiate Funding Services.

The Impending Threat

The bankers scoff at accusations that they are motivated by greed. They say it is shortsighted to not see the danger that the program's continued growth poses to the future of the student-aid programs.

Currently, the government makes up the difference to lenders when the interest rate that is set on student loans in a given year exceeds that which borrowers in previous years have "locked in." For example, with all of the borrowers who are refinancing their loans this year, the government will be required to make payments to lendersfor up to the next 30 yearsfor every year that the interest rate on student loans rises above 4 percent, the average rate for loans this year.

If the consolidation program's rapid growth goes unchecked, lenders say, the government's costs will skyrocket, and, as a result, lawmakers might look to the other student-aid programs to find savings. "These are costs that could come back to haunt us down the road," said John Dean, a lawyer for the Consumer Bankers Association.

The lenders are hoping that they can persuade the major higher-education groups of the impending threat that an unfettered consolidation program poses to aid programs. While renewing the Higher Education Act, they add, Congress can take money it would have spent on the consolidation program and use it to finance colleges' top goal of getting the federal loan limits increased.

Higher-education lobbyists say that the current limits on what students can borrow from the federal government$2,625 for a first-year student, and $23,000 over an undergraduate careerare financially out of date and politically out of touch with today's levels of student needs. With the federal budget in deficit and a soft economy, it will be difficult for lawmakers to afford raising the loan limits without offsetting the costs by exacting savings from the other student-aid programs.

Choosing Sides

Already, at least one group of college officials has aligned itself with the bankers. Speaking at the Consumer Bankers Association meeting last month, leaders of the National Association of Student Financial Aid Administrators indicated that they would urge Congress to change the consolidation program so that borrowers would no longer be able to lock in low interest rates.

In a letter outlining its preliminary recommendations for reauthorization, the aid-administrators' association wrote that is also considering asking Congress to impose "a modest" fee on borrowers who wish to consolidate their loans. Money earned from that fee could be used "to gain other benefits, such as increased loan limits or elimination of the origination fee, in the zero-sum budget game that will be played in this reauthorization."

The other major college groups have not weighed in on the issue yet and may not take an official stand when they send their reauthorization recommendations to Congress this month.

"I don't know if we will say anything about consolidation," says Terry W. Hartle, senior vice president for government and public affairs at the American Council on Education. "We're working through a large number of proposals now, and it's possible, but not certain, that we will address it."

Still, some college lobbyists privately say that they are considering supporting the bankers' proposals, primarily because they want to free up money to spend on their own priorities, such as raising the loan limits.

Taking such a stance would pit the college groups against student advocates. Not only do the national groups that represent students oppose changes to the consolidation program, but they also reject calls for loan-limit increases.

"Charging students to consolidate in order to raise loan limits only cuts off students' noses to spite their faces," says Ms. Rube of the State Public Interest Research Groups. "If schools and other groups can't see that, they fail to understand that such proposals would only escalate student debt, making college less, instead of more, affordable."