Combatants Alter Tactics in Fight Over Student-Loan Consolidation.

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Author: Burd, Stephen

Dateline: Washington

A looming increase in the interest rates that borrowers must pay on federal student loans is forcing the combatants in a fierce fight on Capitol Hill to reconsider their tactics.

The battle, which has been raging in Congress for the past two years, is over the future of a government program that allows borrowers to refinance their student loans. No other student-aid issue has been as contentious as lawmakers consider legislation to extend the Higher Education Act, the law that governs most federal student-aid programs.

On one side of the debate are the Republican leaders of the U.S. House of Representatives Committee on Education and the Workforce. They have been pushing a proposal that would change how the interest rate is calculated for student-loan borrowers who consolidate their debt. The government, they say, has made the federal loan-consolidation program too attractive to borrowers -- and too costly to taxpayers -- by allowing borrowers to lock in low, fixed interest rates for up to 30 years. Instead, the legislators have pushed a proposal, championed by the student-loan industry, that would shift the rate to one that varies from year to year based on market conditions but is capped at 8.25 percent.

On the other side are the panel's top Democrats, as well as student advocates and companies that specialize in refinancing loans. They argue that Congress should not make it harder for borrowers to repay their loans when so many students are buried in debt.

The debate has been occurring at a time when the consolidation program is more popular than ever. In order to lock in interest rates of about 3.5 percent for the life of their loans and save thousands of dollars each, borrowers consolidated about $44-billion worth of loans in 2004, almost four times as much as in 2000.

But in July, interest rates on student loans are expected to rise for the first time in five years. The Congressional Budget Office projects that the rate will jump by at least two percentage points, to about 5.5 percent, and will continue to grow for the foreseeable future. That change could significantly alter the terms of the debate. "This is no longer going to be such a black-and-white issue," says John Dean, a lawyer for the Consumer Bankers Association, which supports a shift to a variable rate.

As rates rise, it will become increasingly difficult for Democrats and their supporters to argue solely for the fixed-rate option. They acknowledge that borrowers who wish to consolidate their loans will be worse off if they have no other choice but to lock in higher interest rates.

With that in mind, student advocates and consolidation-company officials are shifting their stance. Having the government offer variable-rate loans is not a bad idea, they say, as long as it also maintains a fixed-rate option for borrowers. "People should be able to choose the option they want," says Alik Widge, an advocate for the National Association of Graduate-Professional Students. "Chances are they will be able to figure out which one fits their needs better."

At the same time, the prospect of rising rates threatens to undercut the Republicans' central argument for making the shift: that it is too expensive for the government to continue to offer fixed-rate consolidation loans. As interest rates grow, the savings that the government would see from shifting to a variable rate diminish. That is because the government makes up the difference to lenders when interest rates exceed those which borrowers have locked in. As more and more borrowers lock in higher rates, the amount that the government must make up for these loans shrinks.

As a result, loan-industry officials are scrambling to get the proposal on a faster-moving vehicle than the reauthorization bill, which is unlikely to be completed this year. Lenders hope that lawmakers will consider making the change as part of "budget reconciliation" legislation -- a measure in which legislators propose cuts in federal mandatory programs, such as Medicare, Social Security, and student loans, to reduce the government's budget deficit -- if Congress moves forward with that process this year.

"Given the availability of large savings from moving to a variable rate as soon as possible," Mr. Dean says, "we would hope that Congress would explore that option."

With the dispute in Congress over the consolidation program heating up, some lawmakers and college groups have offered proposals designed to find a compromise. (See table below.)

The one with most promise has been floated by Rep. Thomas E. Petri, a Wisconsin Republican. Under that plan, borrowers would be given the option of consolidating with a fixed or a variable rate, capped at 8.25 percent. The fixed rate would be indexed to a longer-term Treasury instrument that would produce a higher rate than borrowers pay now. In fact, those who refinance would almost always pay less if they chose a variable rate.

Borrowers are in the best position to know what type of plan works for them, Mr. Petri says. He wants to model the consolidation program on the mortgage market, where borrowers must pay a little more to lock in an interest rate and have the advantage of knowing what their monthly payments will be.

"I believe that most citizens would be comfortable having similar choices when refinancing their student-loan obligations," he says.

The plan has won the backing of some of the major loan-consolidation companies. Those officials, who until now fought almost exclusively to save the fixed rate, acknowledge that their position has evolved. Given the "economic conditions we are likely to see in the future, we think the opportunity to choose between fixed and variable consolidation-loan interest rates should be given to borrowers," says Jim Newell, vice president of government relations for Collegiate Funding Services.

Members of groups representing graduate and professional students are also likely to support the congressman's plans, as they have made a similar proposal.

Mr. Petri says that both Republican and Democratic lawmakers have expressed interest in his plan. With the change in the way the fixed rate is calculated, and another provision that eliminates some "excess earnings" of lenders, Mr. Petri says his plan would produce as much, or even more, savings for the government than the provision in the House bill. The Congressional Budget Office has not yet estimated the cost of Mr. Petri's plan.

But requiring borrowers to pay more for a fixed-rate loan may be a deal killer for groups that lobby for undergraduate students.

Kate L. Rube, higher-education adviser to the State Public Interest Research Groups, says her organization supports giving borrowers who seek to refinance the choice of a fixed or a variable rate, but doesn't want to see the terms become less generous. "We shouldn't go backwards in terms of the benefits borrowers are receiving now," she says.

The student groups would also like to see the cap on variable-rate loans reduced to 6.8 percent.

Still, student advocates' primary goal is to preserve the fixed-rate option, says Jasmine Harris, the legislative director for the United States Student Association: "It's a great benefit for borrowers."

For loan-industry officials there is no more important goal this year than to get Congress to shift how the rate is calculated.

They have argued that the billions of dollars that the government provides in subsidies each year to keep the costs of fixed-rate consolidation loans cheaper for borrowers would be better spent giving more benefits to current and future students.

But they also have another motive. Sallie Mae and other large lenders have lost a significant share of the refinancing market to consolidation companies. In large part, they are seeking to have lawmakers prevent borrowers from getting fixed-rate consolidation loans so that refinancing would be less appealing. They hope that the change would force these companies out of the market.

The lenders know that they have to act fast. The Congressional Budget Office has estimated that shifting to a variable rate this year would save the government $2-billion. But as rates rise, the amount of savings plummets. By 2008 the government would actually lose money by making the change.

Loan-industry officials are trying to persuade legislators to look to the consolidation program for savings as part of the budget-reconciliation process. If that were to happen, colleges and students would benefit also, they say.

That is because, they say, the leaders of the House education committee are depending on savings from the loan programs to offset the costs to the government of other proposals in their reauthorization bill that would help students, such as an increase in the amount they are allowed to borrow in their first two years of college and a cut in the origination fees they must pay to obtain their loans.

If lawmakers move ahead with reconciliation this year, but don't look to the consolidation program for savings, they will have to make other cuts to the loan programs. That could leave the education committee's leaders empty-handed.

"Anything that can be done to minimize the impact of reconciliation on reauthorization needs to be explored," says Mr. Dean, of the Consumer Bankers Association.

But opponents of the proposed change say the issue should be dealt with in reauthorization, where lawmakers have more time to engage in substantive policy discussions.

"Policy considerations are ideally the basis for making program changes, as opposed to the need to cut programs for budgetary reasons," says Mr. Newell, of Collegiate Funding Services. "The results are always better for students."

Under current law, student-loan borrowers get a fixed interest rate based on the weighted average of the rates of their combined loans, rounded to the nearest eighth of a point and capped at 8.25 percent. HR 609, a bill being considered by the U.S. House of Representatives, would no longer allow borrowers to lock in low interest rates for up to 30 years, as they can now. Instead they would be charged a rate that varies each year according to market conditions. The cap would remain at 8.25 percent.

Legend for Chart:

B - Supporters
C - What it would do
D - Rationale
E - Outlook

A

    B

        C

            D

                E

1. Helping those most in need

   U.S. Rep. Robert E. Andrews, a New Jersey Democrat

      Would require most borrowers who consolidate their
      loans to pay a variable rate capped at 8.25 percent.
      Borrowers with higher debt burdens--those putting
      at least 8 percent of their annual income into loan
      repayment--would get a lower variable rate and a reduced
      cap. For example, the rate cap would be lowered to 5
      percent for borrowers who could show that their monthly
      payments exceeded 10 percent of their total income, and
      to 3 percent for those whose monthly payments exceeded
      12 percent.

         The proposal is designed to deal with one of the
         main criticisms of the loan-consolidation program:
         Billions of dollars in loan subsidies have been spent
         to help doctors, lawyers, and other affluent
         professionals refinance their loans at the government's
         expense. Under Mr. Andrews's plan, the greatest
         benefit would go to borrowers most in need of the help.

            The plan has failed to pick up steam; most
            student-aid experts believe that it would be too
            complicated to carry out. It is unclear, for
            instance, how lenders and the government would be
            able to verify borrowers' claims about their
            debt-to-income ratios.

2. Lowering the cap

   Lobbying groups like the American
   Association of State Colleges and Universities and the
   National Association of Student Financial Aid
   Administrators

      Would require borrowers who refinance their
      loans to pay a variable rate. However, the rate
      cap would be lowered to 6.8 percent.

         With interest rates on the rise, the plan would
         allow borrowers to avoid having to lock in a high
         rate. Throughout much of the 1990s, borrowers who
         refinanced in the guaranteed-student-loan program
         were required to pay a fixed interest rate as high
         as 9 percent, supporters of the proposal say.

            Not good. The proposal is unlikely to win support
            from student groups, which want borrowers to
            continue to have the option of a fixed rate.
            And Republican leaders of the House Committee on
            Education and the Workforce don't like the
            plan because of its cost. The government is
            required to make up the difference to lenders
            when interest rates exceed the cap. Therefore,
            the lower the cap is set, the higher the price
            tag for the U.S. Treasury.

3. Giving borrowers a choice

   U.S. Rep. Thomas E. Petri, a Wisconsin Republican

      Would give borrowers the option of consolidating with
      a fixed or a variable rate, capped at 8.25 percent.
      The fixed rate would be indexed to a longer-term
      Treasury instrument that would produce a higher rate than
      borrowers pay now--in fact, borrowers would almost always
      pay less if they chose the variable rate.

         Supporters of the proposal say it would be a mistake
         to get rid of the fixed-rate option altogether. Many
         borrowers, who like the predictability of knowing what
         their monthly payments will be, would prefer to lock
         in an interest rate, even if it is costlier for them
         to do so. As in the mortgage market, borrowers would
         be asked to pay a little more to take advantage of
         this benefit.

            More promising than the other two alternatives.
            Groups representing graduate and professional
            students have offered similar proposals. Other
            student groups and Democratic leaders of the
            House education committee support the idea of
            giving borrowers options. But they don't want to
            see the fixed-rate option become less generous
            than it is now. They would also push lawmakers
            to lower the cap on variable-rate loans to 6.8
            percent.

SOURCE: CHRONICLE REPORTING

PHOTO (COLOR): Rep. Thomas E. Petri, a Wisconsin Republican, has proposed a compromise in the refinancing debate that would give borrowers the option of consolidating their loans with a fixed or a variable rate, capped at 8.25 percent

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By Stephen Burd