Changes to the Federal Consolidation Loan Program

Current Situation:

The Federal Student Loan programs allow a borrower to consolidate their student loan(s).  The program results in a single loan with terms extended from the original 10-year term to between 12 and 20 years.  The interest rate for the consolidation is a fixed rate that is calculated by a weighted average of all the underlying loans and cannot be changed.  Consolidation can be made up of a combination of Federal Family Education Loans (FFEL), Federal Direct Loans (FDL) and Perkins Loans.  Statute currently states that a borrower whose loans are held by a single lender must consolidate with that lender unless their consolidation is denied or the lender does not offer the income contingent repayment option.

Issues:

The existence of the Consolidation loan program is beneficial to borrowers both as a tool to extend high debt level to a longer termed, lower payment loan and to assist in preventing student loan defaults.

Proposed:

Continue the Consolidation loan program with the following changes:

Eliminate the "single holder rule" that currently restricts borrowers whose entire loan portfolio is held by a single lender to consolidate with that lender only.  This law limits borrower choice, especially when considering that different consolidation lenders offer varying borrower benefits and incentives.  It should also be noted that more than one third of all Federal Student loans are held by one particular private loan holder which means the likelihood of a borrower falling under the single holder rule is relatively high.

Change the current fixed interest rate structure to a variable rate that can be capped at the future loan cap of 6.8%.  The current consolidation interest rate formula calculates the weighted average of the variable rate underlying loans and rounds up to the nearest 1/8 of a point.  This means that, depending on the economy, borrowers consolidating the same loans at different times can end up with dramatically different fixed interest rates that are based strictly on the timing of the application.

Possible Objections:

The single holder rule was intended to prevent the "pirating" of student loan lenders' portfolios by competitors.  This could potentially put some of these lenders in financial hardship as they estimate and depend on the revenue from their existing portfolio to stay competitive.

The fixed rate resulting from a consolidation loan assists borrowers by enabling them to eliminate the risk of interest rates increasing and resulting in a higher monthly payment amount and an increased amount of total interest paid throughout the life of the loan.

Counter Argument:

There are very few, if any, student loan holders that do not offer a consolidation program.  Eliminating the single holder rule would only further encourage all lenders to offer the best possible borrower benefits in order to maintain their competitiveness and maintain their existing portfolios.

The current interest rate formula, and historically low rates that the industry has recently experienced, has turned the program away from Congress' original intent for the program and turned it instead into a sort of refinancing option for borrowers.  While the objection above discusses the risk of higher total interest monies paid, consolidation itself generally results in a significant increase in the total amount paid over the life of the loan.  By advertising the lower monthly payment aspect of consolidation, borrowers may not understand this increase or the potential loss of some borrower benefits that may result from consolidating.