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Borrowers Who Consolidate Student Loans Would Lose Interest-Rate Break Under Republican Plan

Borrowers in federal student-loan programs could lose the chance to consolidate their loans at a low fixed interest rate -- and save thousands of dollars -- under a plan that the Bush administration and Republican leaders in Congress are expected to start pushing this week.

White House officials and leaders of the U.S. House of Representatives are urging members of the House Appropriations Committee to include a provision in an emergency spending bill for the 2002 fiscal year, which the panel is planning to introduce this week, that would change the interest rate charged to borrowers who consolidate their federal loans from a fixed to a variable rate. They say that the money saved from that change could then be used to cover a $1.3-billion shortfall in the budget for Pell Grants.

This proposal is particularly controversial right now because as of July 1, the interest rate on student loans is scheduled to decrease from 6 percent to a record low of about 4 percent. Borrowers who consolidate their loans then will be able to lock in the lower rate for the lives of their loans.

Student advocates say this is a chance of a lifetime for borrowers to reduce their loan costs. Those with $20,000 in loans, for example, could save up to $5,000 over 20 years. But some lenders have been sending out distress signals about what this would mean for their bottom lines.

Over the last several months, lobbyists for Sallie Mae, the country's largest financer of student loans, and some other lenders have urged the Bush administration and Republican Congressional leaders to change the interest rate on consolidation loans from a fixed to a variable rate, to make loan consolidation a less attractive option for borrowers. Administration officials and House leaders have latched onto the idea as a way to cut government spending on the loan programs.

College lobbyists and student advocates say they are outraged by these developments. "This would be a terrible deal for students," said Ellynne Bannon, a higher-education adviser with State Public Interest Research Groups. "I'd hope that lawmakers would not put the interests of students behind those of lenders, who are only seeking to increase their profits."

Congress created the government's loan-consolidation program to make it easier for borrowers to repay their federal loans, which have variable interest rates that are adjusted annually. 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 take up to 30 years to repay them.

Critics of the consolidation program, including Sallie Mae and some other lenders, say that the program has cost the government billions of dollars in loan subsidies and that it has mostly helped doctors, lawyers, and other affluent professionals refinance their loans at the government's expense. They say this money would be better spent on making college more affordable for low-income students, by increasing spending on Pell Grants, or by eliminating the origination fees that borrowers must pay to obtain their loans.

Student advocates and college lobbyists would like to see greater spending on Pell Grants, and the elimination of the student-loan origination fees, but not at the expense of the loan-consolidation program. The program makes repayment more manageable for student borrowers who are buried under loan debt, they say. By eliminating borrowers' ability to get fixed rates, they say, the proposal that House leaders and Bush administration officials are considering would make the loan-consolidation program so unattractive for borrowers that it would effectively kill it.

Kathleen deLaski, the chief spokeswoman for Sallie Mae, says that making consolidation less attractive to borrowers "makes good fiduciary sense" for the government and taxpayers. "Federal subsidies should be going to provide access to college for students, not to help borrowers who have been out of college for a number of years lock in 30-year rates," she says.

But student advocates and college lobbyists say that Sallie Mae is more interested in its profit margin than in the concerns of low-income students. They note that a financial analyst has recently expressed concerns about what the impending drop in interest rates on consolidation loans -- from 6 to 4 percent -- will have on Sallie Mae's profits.

In mid-April, Sallie Mae's stock price fell almost 4 percent in one day after a financial analyst from UBS PaineWebber released a report warning that a surge in "consolidation activity" due to the new low rates "could put a downward bias on our assumptions for Sallie Mae's portfolio growth and its interest margin."

Sallie Mae's stock rebounded quickly after other financial analysts played down those concerns. Charles A. Gabriel Jr., an analyst with Prudential Financial, who reported having "a material position" in Sallie Mae, said that "fears of loan consolidation have seldom met worst-case expectations." He explained that when interest rates have dropped sharply in the past, demand for consolidation loans has seldom reached the levels feared.

The concerns were also overblown, Mr. Gabriel said, because of "an emerging effort to deal legislatively with this issue," adding that "we suspect Sallie Mae's strategic maneuvering and effective lobbying is probably set once again on a positive corrective course."

Mr. Gabriel said that he had little doubt that Sallie Mae would succeed in persuading Congress and the Bush administration to change the interest rate on consolidation loans from a fixed to a variable one. "The net effect of passage of this measure (we believe) would be to avert the added threat of portfolio erosion by reducing the incentives for refinancings/consolidations," he said.
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