Background Information On Consolidating Student Loans

STUDENT LOAN CONSOLIDATION
By: Saul Spigel, Chief Analyst

You asked for background information on consolidating student loans, particularly reconsolidating or refinancing them, and what the General Assembly might do to help borrowers.

SUMMARY
Federal law, the Higher Education Act of 1965 (HEA), governs student loans and their consolidation; the General Assembly has no authority in this area. The law allows people who have borrowed money under various federal loan programs or from multiple sources to consolidate their loans after they leave school. Consolidation allows borrowers to merge several loans with varying repayment terms and interest rates into a single loan and extend repayment to up to 30 years at a fixed monthly payment.
The interest rate on consolidation loans is fixed. It is determined by the weighted average of the loans being consolidated. Rates are capped at 8. 25%. Under the “single holder” rule, a borrower whose loans are all held by one lender can, with some exceptions, ask only that lender for consolidation.
In most cases, a borrower can consolidate loans just once. Federal law prohibits “reconsolidation,” that is refinancing an existing consolidated loan. This means that borrowers who consolidate at a relatively high interest rate (although it may be lower than the rates on the original loans) cannot take advantage of future rate decreases.
Congress is currently considering legislation to reauthorize the HEA. The College Access and Opportunity Act (H. R. 609) would, among many provisions, allow variable rate consolidation loans, still with an 8. 25% cap. This would help future borrowers who consolidate at a high rate, but it would not help people who have already consolidated. But permitting reconsolidation would increase federal subsidy costs because the federal government guarantees private lenders a market rate return and must make up the difference between the rate the borrower pays and that guaranteed rate.

LOAN CONSOLIDATION

Eligible Loans
The loans eligible for consolidation are: subsidized (based on financial need) and unsubsidized Stafford Loans; Parent Loans for Undergraduate Students (PLUS); Supplemental Loans for Students (SLS); Perkins Loans; and Nursing Student, Health Professions Student, and Health Education Assistance loans. A borrower must be in the grace period (the six months after leaving school) or have begun repayment on each loan he wants to consolidate. Loans in default can be consolidated only after the borrower makes satisfactory repayment arrangements with the loan holder or agrees to repay the consolidating lender under an income-sensitive repayment schedule (see below).

Consolidation Loan Terms
The above eligible loans have 10-year terms. A consolidation loan repayment term can be up to 30 years. The term is determined by the total consolidation loan balance plus the balances of other education loans as follows:
• less than $ 7,500—10 years;
• between $ 7,500 and $ 10,000—up to 12 years;
• between $ 10,000 and $ 20,000—up to 15 years;
• between $ 20,000 and $ 40,000—up to 20 years;
• between $ 40,000 and $ 60,000—up to 25 years;
• $ 60,000 or more-30 years
Consolidation loan interest is fixed. The rate is determined by weighted average of the loans being consolidated, rounded up to the nearest one-eighth (1/8) percent. Rates are capped at 8. 25%.

Consolidation lenders can offer four repayment plans:
• Standard: the monthly payment amount is fixed over the life of the loan
• Income Sensitive: monthly payments are based on, and change with, the borrower’s income
• Graduated: monthly payments start low and gradually increase over the life of the loan
• Extended: for loans over $ 30,000, borrowers can extend payments over 25 years under a level or graduated repayment schedule
A borrower whose loans are all held by a single lender must request consolidation from that lender. This is called the “single holder” rule. But a borrower with a single lender can seek a consolidation loan from another lender, but he must certify that (1) he sought and was unable to obtain a consolidation loan through the institution that holds his Stafford or PLUS loan or (2) the holder would not provide a consolidation loan with an income-sensitive repayment schedule. People who have borrowed from multiple sources can seek a consolidation loan from any eligible lender.

Consolidation Pros and Cons
Consolidating student loans presents both benefits and drawbacks.
By extending the payment period, consolidation lowers a borrower’s monthly payment. It also yields a single billing statement and removes the risk inherent if variable rates rise. But borrowers pay more in interest because of the longer repayment period and cannot benefit if rates drop after they consolidate.

Reconsolidation
Once a borrower consolidates loans, federal law prohibits him from reconsolidating, that is refinancing, them. But the law permits a borrower to obtain a new consolidation loan if (1) he has at least one outstanding eligible loan that was not included in the initial consolidation or (2) consolidated loans then borrowed again under an eligible loan program.

PENDING CONGRESSIONAL ACTION
Congress is currently considering a bill to reauthorize the HEA. The current version of this legislation, H. R. 609, The College Access and Opportunity Act, would (1) allow variable rate consolidation loans, still with an 8. 25% cap, and (2) repeal the “single holder” rule, thus letting borrowers shop around for the best terms on a consolidation loan. But it does not include a provision to permit reconsolidation.
According to a recent Congressional Research Service report on student loan issues involved in HEA reauthorization, the reconsolidation debate is linked to the larger debate over whether to continue fixed rates for consolidation loans or switch to variable rates. Borrowers who consolidated at a fixed rate during high interest periods in order to lower their monthly payment lose (1) the more advantageous variable rates they may have had on the underlying loans and (2) the ability to take advantage of more favorable rates in the future.
Switching to variable rate consolidation loans, the path H. R. 609 takes, is one way to address this problem. But it does not help people who have already locked in. Another way is to allow borrowers multiple refinancing opportunities, that is reconsolidation. This path helps all borrowers, but, because the federal government guarantees private lenders a market rate return and must make up the difference between the rate the borrower pays and that guaranteed rate, it would increase federal subsidy costs.