Student lenders are putting up their dukes in response to a federal proposal to cut origination fees on competing government loans.

At issue is a plan by the Department of Education to lower the origination fee in its direct loan program to 3% from 4%. The cut, meant to bring the fee in line with those of private-sector lenders, is included in a package of discounts proposed June 16.

The Consumer Bankers Association said it may sue the agency, pointing to a law covering the direct loan program that sets origination fees at 4% of a loan's principal. The proposed reduction may mean that further cuts are on the way, which would undercut the private lender program, said Joe Belew, the president of the CBA.

"It would be a very clever way to disadvantage the (private-lender) program," he said. "It opens a Pandora's box."

The Department of Education argues that last year's student loan reforms give it the power to make the cut. The proposal stated students should receive the "same terms, conditions, and benefits" in both programs. An agency spokesman declined to comment further.

The proposed package also includes interest rate cuts of 25 basis points for borrowers who pay electronically and 60 basis points for students who consolidate their loans before or shortly after graduation.

Private lenders pitted against the origination fee cut are "looking at a very narrow interpretation of the law," said Thomas A. Butts, associate vice president for government relations for the University of Michigan.

"We'd agree with anything that would provide better benefits in both programs," Mr. Butts said. "More ought to go to the programs' purpose," he said.

But the private-lender program has become less profitable in recent years, Mr. Belew said.

"The administration has used the budgeting process to force cuts for years, so the margins have gotten exceptionally skinny," he said.

The direct government loan program, introduced in 1994, was designed to be a more affordable alternative to the government-guaranteed loan program by banks and other lenders. The programs became fierce competitors, with banks losing a battle last year to stop interest rate cuts on their lending.

The interest rates for both programs now match, at 6.86% for current or deferred students or those in a grace period and 7.46% for former students.

The direct loan program is available through about 1,230 colleges and universities and had $23.5 billion outstanding on June 30.

The private-sector government guarantee program, started in 1965 and called the Federal Family Education Loan Program, is available at 3,642 schools and had $124.4 billion outstanding. Schools may participate in both programs.

The direct loan program originates about one-third of student loan volume, according to the Department of Education. That is half of what the agency originally predicted for the 1998-99 school year.

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