In Focus: Banks Fight Discount For Consolidating Insured Student Loans

Congress has brokered a truce in the battle over interest rates paid on new government-guaranteed student loans, but a new fight has broken out over borrowers who consolidate their college loans into one credit.

On July 1 a little-noticed provision in a 1993 law kicked in cutting the interest rate students may be charged by 80 basis points. Swayed by lenders who argued that the cut would make student lending unprofitable, Congress agreed to soften the blow by paying lenders a 50-basis-point subsidy.

However, now bankers say the Education Department has been illegally undercutting the private sector by charging borrowers who consolidate loans the post-July 1 rate.

The industry is asking Congress to make it clear that borrowers who got their student loans before July 1-including loans being consolidated into a single credit-must pay the higher rate in effect through June 30. The interest rate on loans made before July 1 is the Treasury-bill rate plus 3.1%.

"The Education Department has unilaterally chosen to pursue policies that tip the scales in favor of the government's direct-lending program," said Mark R. Cannon, executive director of the Coalition for Student Loan Reform, which represents state and nonprofit guarantee agencies. The agencies partner with banks to administer private-sector student loans.

Though no one tracks loan consolidations handled by the private sector, the government receives approximately 9,000 applications to consolidate student loans every month.

When Congress approved legislation that would pay banks a permanent 50- basis-point subsidy for all new student loans, the House version explicitly forbid the government from applying the new lower interest rate on consolidated loans. But the Senate version makes no mention of the dispute.

A compromise will not be worked out until Congress returns in September, but industry lobbyists are encouraged that several key lawmakers have complained about the Education Department's move.

With others on his panel, House Education Committee Chairman William F. Goodling warned that the department has not solved management problems that led to a shutdown of its consolidation program last year. "No evidence exists to suggest that ... the program is prepared to handle a potential surge in applications that could result from the new interest rate," the Pennsylvania Republican wrote in July 22 letter to Education Secretary Richard Riley.

The Education Department's consolidation program was forced to shut down last fall, stranding 84,000 applicants. Today the government has a backlog of 18,000 applications.

Industry groups argue that the lower interest rate for new loans that went into effect July 1 does not apply to consolidation of old credits. "The loan consolidation program was never intended to be a refinancing program, which it would become under the department's action," private lenders complained in a letter to Secretary Riley last month.

"We question whether this is good education expenditure," said John Dean, special counsel to the Consumer Bankers Association. "Should scarce federal dollars go to help former students who already have jobs or to new students who need assistance paying for school?"

Education Secretary Riley has countered that banks are simply trying to pad their profits and said the agency has redesigned the consolidation process and is prepared to handle the influx of new applicants.

In an Aug. 7 letter to Rep. Goodling, Mr. Riley said private-sector lenders ought to also drop their rates for borrowers who consolidate. "We urge that consolidation loan borrowers in both programs receive the same low interest rate," he said.

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