Education Department Allows Use of Loophole in Student-Loan Consolidation.

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Author: Burd, Stephen

Dateline: WASHINGTON

THE U.S. Education Department announced last week that it will, for the first time, allow hundreds of thousands of students to consolidate their federal guaranteed loans while they are still in college.

The department's decision is big news for those students, as it will enable them to lock in historically low interest rates over the lives of their loans, and save thousands of dollars, before the rates are reset in July. Budget analysts project that the rates--which are now as low as 2.8 percent--will jump by as much as two percentage points on July 1, and will continue to grow over the next several years.

"The Department of Education should be applauded," said Kate L. Rube, higher-education adviser to the State Public Interest Research Groups, which advocates for students. "Anything that would help more borrowers consolidate at the low rates available right now is something we support."

Borrowers in the federal direct-loan program, in which the government provides loans directly to students through their colleges, are already allowed to refinance their debt while they are in college. But under federal student-aid law, borrowers in the competing guaranteed-loan program, in which banks and other lenders provide government-backed loans to students, are not allowed to do so until they begin paying off their loans.

With the interest-rate increase looming, some financial-aid administrators and lenders found a loophole in the law that they said would allow guaranteed-loan borrowers to lock in the low rate. Under the Higher Education Act, borrowers can choose to repay their loans while in college. The officials realized that students who entered repayment could then consolidate their loans and defer their payments on the consolidated loans until they graduate.

In guidance issued last week, Sally L. Stroup, the Education Department's assistant secretary for postsecondary education, endorsed that approach.

Nancy C. Coolidge, who lobbies on student-aid issues for the University of California system, has championed the loophole approach and was delighted with the ruling.

For the last two months, Ms. Coolidge has been pleading with her colleagues across the country to make their students aware of "this unique opportunity." In an e-mail message to an Internet discussion group for financial-aid administrators last month, she noted that without the change, a guaranteed-student-loan borrower who was in the third year of a four-year professional-school program and had taken out $18,500 in loans per year would have to pay as much as $20,000 more than an identical student with direct loans.

"I could find no public-policy basis for such inequitable treatment," Ms. Coolidge said last week, explaining why she has devoted so much time to this effort.

While many lenders have rushed to help students in the guaranteed-loan program refinance their debt, some loan-industry officials have argued against the approach advocated by Ms. Coolidge.

In fact, in correspondence with the Education Department, officials with the National Council of Higher Education Loan Programs, which lobbies on behalf of loan-guarantee agencies, questioned the legality of providing consolidation loans to students at colleges in the guaranteed-loan program. Brett E. Lief, the group's president, said that department officials had asked his organization for its views on the lawfulness of the approach.

Beyond the legal issues, Mr. Lief says he was concerned that the huge surge in demand for consolidation loans would be extremely costly for the government and could imperil future increases in spending on federal student aid. 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. With hundreds of thousands of students consolidating their loans this year, the government will be required to make payments to lenders for up to the next 30 years for every year that the interest rate on student loans rises above 2.8 percent.

"We want to make sure that people would look at the broader public-policy question, which is ensuring that future students would not be deprived of aid because of the money we're spending to help current students," he said.

In the rush to consolidate, Mr. Lief also worries that students won't have the time to consider whether doing so is in their best interest. Those who consolidate their debt, for example, will lose the six-month grace period they would normally have after graduating before having to begin repaying their loans.

"This is going to be like the charge of the Light Brigade," he said. "And that's going to make it difficult for borrowers to practice the due diligence they need to determine that this in their best interest."

Mr. Lief is among the loan-industry officials who have been calling on Congress to change how the interest rate is calculated for borrowers who refinance their debt. Under the lenders' proposal, which has received the backing of the Bush administration and key Republican lawmakers, borrowers would no longer be able to lock in low, fixed interest rates. Instead, the interest rate on consolidation loans would vary from year to year, based on market conditions.

Advocates for students, who are fighting to preserve a fixed-rate option, say that the department's decision in this case shows how beneficial it is for borrowers to be able to lock in a low rate.

"We just hope that this option continues to be available," said Ms. Rube, of the State Public Interest Research Groups.

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By Stephen Burd