Funds for student consolidation loans may be cut
By Dana Dratch • Bankrate.com

Both the White House and Congress are taking aim at programs that allow students to consolidate their student loans to reduce the costs of paying them back.

Are these programs likely to disappear? Not likely.

"Consolidation is a big issue," says Kenneth Redd, director of research and policy analysis for the National Association of Student Financial Aid Administrators. "It's not something Congress is going to change willy-nilly."

But a couple of new twists could change the terms for students and parents who borrow money. The biggest proposed change: a choice between a variable rate and a fixed rate when borrowers consolidate multiple loans into a single monthly payment.

That change is part of the president's budget, says William Graham, director of cost estimation and analysis for the budget service at the U.S. Department of Education.

The president's proposal also cuts the amount of government money going into student loan consolidation by more than half, while estimating a 25 percent decline in the volume of consolidation loans, Graham says.

In addition, the president's budget would shift some costs, Graham says. The budget asks that the origination fee charged to lenders be increased from one-half of 1 percent to a full percentage point, he says. And a new repayment schedule, which could allow students the option of longer repayment periods at a variable rate, could generate more funds in interest, says Graham.

In 2004, the most recent year documented, students and parents took out 1.6 million consolidation loans totaling $43.7 billion, according to figures from the U.S. Department of Education.

For 2005, the government estimates spending $5.6 billion to back an estimated $43.8 billion in student loan consolidations, says Graham. The president's 2006 proposal would cut the government's contribution to $2 billion, with the estimated loan volume dropping to $32.9 billion, he says.

Another new point from the proposal: Students who had received all their loans through one lender would be allowed to shop around when they decide to consolidate. As it is now, only students who borrow from more than one lender -- or took all their loans from the Department of Education direct loan program -- have that privilege.

Any changes made from the president's proposal would take effect with loans consolidated on or after July 1, 2006, says Graham.

In Congress, a piece of legislation aimed at reshaping several aspects of higher education also is calling for changes to the student loan consolidation program.

The congressional bill, backed by Rep John Boehner (R-Ohio), proposes that consolidation loans offered for federally backed loans, such as the Stafford and PLUS loans, should offer borrowers the flexibility to choose between a variable rate and a fixed rate, depending on their individual financial needs.

"I can't say that I'm opposed to that," says Ronald W. Johnson, co-author of "Financial Aid for College: Understand and Plan Your Funding Options" and director of financial aid at UCLA. "I'm hoping the variable interest rate does allow the federal government to provide more money for financial aid so that students have the access."

"Young people need a break on student loan payments to make ends meet," says Barry Morrow, president and CEO of Collegiate Funding Services. A variable rate could hurt students because "it takes away some of the certainty" of regular fixed payments, he argues.

But Morrow doesn't believe that consolidation itself is in any danger. If you read the president's budget, "he certainly is not ending consolidation, by any means," he says.

Financial aid analysts are wondering just how much of the current proposals will be included in the final bill.