Wisconsin Lawyer
Vol. 75, No. 7, July 2002

Consolidating Law School Debt

• Figures

by Richard D. George

Unlike many areas of law, there is little room for interpretation of the dictates or entitlements of the Higher Education Act (the Act)¹ as they relate to Federal Consolidation Loans.² But while the Act itself may be that rare piece of comparative clarity as it applies to consolidation loans, the choice it provides borrowers most certainly is not. That choice - to consolidate or not to consolidate - requires more economic than legal analysis.

This article provides law students and lawyers with student loans some of the key facts they need to make that choice. It also provides the contact points for more detailed inquiry and process questions beyond the scope of this primer. Importantly, however, readers must understand that, unlike law's goal of evenhanded administration of justice, economics treats us differentially. Accordingly, there is no right choice to the issue of consolidation. There will be significantly different choices based on individual circumstances and personal preference. The following is intended only to enable informed choice, not to influence that choice.

The Basics

A consolidation loan is one of several loan types offered under the Act in the Federal Family Education Loan (FFELP) and William D. Ford Direct Loan (FDLP) programs. While there are certain differences between FFELP and FDLP consolidation loans as noted below, most of the terms and conditions of these two programs are parallel.³ Consolidation loans offer eligible borrowers the opportunity to consolidate all or some of their outstanding educational loans into a single new loan, even if present student loans are of different program or loan type or are held by more than one lender. Almost all federal loan types are eligible for consolidation under the Act.

Loans That Can Be Consolidated. The following federal loan types can be consolidated under the Act:

• FFELP Subsidized Federal Stafford Loans, formerly Guaranteed Student Loans (GSL)
• FDLP Subsidized Stafford Loans
• FFELP Unsubsidized and Nonsubsidized Federal Stafford Loans
• FDLP Unsubsidized Stafford Loans
• Federal Supplemental Loans for Students, formerly Auxiliary Loans to Assist Students (ALAS) and Student PLUS Loans
• Federal Perkins Loans, formerly National Defense/National Direct Student Loans (NDSL)
• Health Professions Student Loans, including Loans for Disadvantaged Students
• Health Education Assistance Loans (HEAL)⁴
• Federal Insured Student Loans (FISL)
• FFELP PLUS (Parent) Loans (note that you may not consolidate your parent's PLUS loan with your own)
• FDLP PLUS Loans
• Subsidized FFELP Consolidation Loans
• FDLP Subsidized Consolidation Loans
• Unsubsidized FFELP Consolidation Loans
• FDLP Unsubsidized Consolidation Loans, including FDLP PLUS Consolidation Loans
• Federal Nursing Loans

Delinquent or defaulted loans can be consolidated subject to borrowers making payment arrangements or evidencing repayment intention.

Eligibility for Loan Consolidation. For FFELP consolidation, you must be in repayment or in the grace period preceding repayment on the loans chosen for consolidation. For FDLP consolidation, you also may consolidate during the in-school period.⁵ If you are in repayment, you must continue to make monthly payments to your current loan holder(s) until these loans have been paid in full by the consolidating lender. If you are unable to make your payments during this process, you should contact your loan holders for alternative arrangements.

Interest Rates. The consolidation loan interest rate is determined when the loan is originated. With the exception of any outstanding balance representing a HEAL loan, the consolidation loan interest is a fixed rate equal to the weighted average of the interest rates of the loans being consolidated rounded up to the nearest one-eighth of 1 percent but not exceeding 8.25 percent. The interest on the portion of a consolidation loan representing a HEAL loan is a variable rate that is adjusted annually on July 1. This rate is set at 3 percent over the bond-equivalent rate of the three-month Treasury bills auctioned during the three months ending June 30.

Repayment Period. The length of your repayment period depends on your total student loan debt. That amount is the total of those loans you choose for consolidation plus "other education loans"⁶ you owe, but which will not be included in your consolidation loan. The maximum repayment periods⁷ for federal consolidation loans are as follows: less than $7,500 - 10 years; $7,500 to $9,999 - 12 years; $10,000 to $19,999 - 15 years; $20,000 to $39,999 - 20 years; $40,000 to $59,999 - 25 years; $60,000 or more - 30 years.

Repayment Options. In most cases, you may choose to repay your consolidation loan through one of four repayment plans:

• Standard Repayment Plan, up to 10 years repayment period
• Extended Repayment Plan, 12 - 30 year repayment period
• Graduated Repayment Plan, 12 - 30 year repayment period
• Income Contingent Repayment Plan,⁸ up to 25 years repayment period.

These basics have not changed substantially since the 1998 reauthorization of the Higher Education Act.⁹ And, while the fixed rate consolidation loan option as outlined has been available since 1998, it has only been in the last two years that interest in and the volume of consolidation loans have exploded.¹⁰ Two factors have driven this growth. The first and most important has been the recent decline in U.S. interest rates that underlie the setting of the variable rates on FFELP and FDLP loans under the Act and, accordingly, the weighted average rates that are locked in by a fixed rate consolidation loan. The second factor - in large part a derivative of the first - has been the emergence of large consolidation loan marketing concerns running sophisticated direct mail and telemarketing campaigns directed at recent graduates urging them not to miss current consolidation loan opportunities.¹¹

And therein lies the choice confronting student loan borrowers. Is this a historic once-in-a-lifetime opportunity for borrowers to lock in low interest rates or a once-in-a-lifetime opportunity for the marketers? Or, as some would suggest, is it an opportunity for both? This leads to the economics.

The Economics

The majority of student loan borrowers have a combination of subsidized and unsubsidized FFELP or FDLP loans.¹² The variable rates on these loans¹³ are set as follows:

Unsubsidized Loans - During grace: 91 day Treasury bill (T-bill) plus 1.7 percent = 3.46 percent. During repayment: 91 day T-bill plus 2.3 percent = 4.06 percent.

Subsidized Loans - During repayment: 91 day T-bill plus 2.3 percent = 5.99 percent.

All loans are variable to be adjusted every July 1 not to exceed 8.25 percent.

The 91 day T-bill reference point is the bill auctioned at the final auction preceding June 1 of each year, and the interest rate on the loans resets accordingly on July 1 of each year.Figure 1 provides the recent 10-year history of the resulting rates, which have averaged 7.55 percent and are currently at 4.06 percent through June 30, 2003. Should the choice be to lock in the current low rates through consolidation? Figure 2 offers an overview of just how important a choice this may be with median cumulative amounts borrowed for professional degree graduates of public and private universities at $61,417 and $73,533, respectively, and the difference in monthly payments as shown in Figure 3.

But while rates that may be able to be locked in today are low by comparison to the 10-year average, the U.S. interest rate environment may not yet definitively have shifted from its recent declines. Figure 4 shows the trend of auctions of the reference bill since January 2002. While the most recent auctions are off the lows, the rate environment remains volatile.¹⁴

Remember, too, it is not only rate but term that impacts how much you may actually pay. The loan comparison at Figure 5 indicates the impact of rate and term on both the monthly payment and total non-net-present value cost.¹⁵

The Choice

So, do you consolidate or not? Here are some final considerations.

• Consolidation is final. Even if you become eligible to reconsolidate through new borrowing, you will have locked in the consolidation loan rate in the weighted average formula for the new consolidation loan.
• Consolidation may cost more in total interest paid and in the potential loss of existing borrower benefits on your FFELP or FDLP loans (auto-debit discounts, prompt and continuous pay discounts, special rebates, and so on).¹⁶ Many lenders do not offer the same discounts on consolidation loans.
• Consolidation may require you to deal with your existing lender, and federal regulations prohibit you from applying to more than one lender at a time. If your FFELP loans are held by only one lender and this lender offers consolidation loans, you must request a consolidation loan from that lender. If multiple lenders hold your FFELP, FDLP, or other federal loans, you may apply for a consolidation loan with a consolidation lender of your choice.
• Consolidation may impact your interest deductions on your tax return. Effective for the 2002 tax year, the 60-month limit on deductibility of qualified education loan interest was eliminated and the maximum deductibility was set at $2,500 per year at increased adjusted gross income ranges of $50,000 - 65,000 for single returns and $100,000 - 130,000 for joint returns.¹⁷
• How do you decide if you really need consolidation? As a rule of thumb, if your education loan payments exceed 8 to 10 percent of your gross monthly income and you are having trouble making payments, you may want to consider consolidation. The 8 to 10 percent guideline should allow borrowers to have enough income to cover rent/mortgage payments, basic living expenses, and other debt service needs, as shown in Figure 6.
• And timing? There is no need to rush. While many lenders can complete a consolidation loan from application to disbursement in less than two weeks, the process can take 10 weeks or more depending on the number of loans and lenders involved. Consolidation loan applications pending at the time of a rate change in the past have been given the benefit of the new lower variable rate in calculating the average weighted interest rate for the consolidation loan. Whether this will occur with applications pending at July 1, 2002 is an open issue. But why rush? The new variable rate of 3.46 percent in grace and 4.06 percent in repayment will be in effect until July 1, 2003, so there is plenty of time to think through this very important choice. And remember, term may be as important as rate.

Additional Resources

The choice is important. Consolidation is not the best choice for everyone and there is a lot more information and help available. To obtain more information on Federal Consolidation Loans (or other programs) or an application, contact your financial aid office, your lending institution, or the following sources:

• www.glhec.org - Web site for Great Lakes Higher Education Corporation & Affiliates including Great Lakes Higher Education Guaranty Corporation, 2401 International Lane, Madison, WI 53704, or call (800) 236-6600 for more information. At this site, you will be able to download an application, use a calculator to estimate the monthly consolidation loan payment, get information regarding how the interest rate will be calculated, review different repayment options, link to the National Student Loan Clearinghouse Loan Locator (www.nslc.org) to find out who holds your loans, and print the Federal Consolidation Loan Information Guide.
• www.mapping-your-future.org - A public service project of several guaranty agencies offering financial aid information for students and families.
• www.loanconsolidation.ed.gov, or by calling (800) 557-7392, for the U.S. Department of Education and details on FDLP consolidation loans.

Endnotes

¹The Higher Education Act of 1965, as amended, codified at 20 U.S.C. section 1071 et seq. (the Act or the Higher Education Act), provides for the establishment of two federal student loan programs, one federally guaranteed through state agencies or state designated nonprofit corporations and the second directly by the U.S. Department of Education. There currently are 36 state or private nonprofit entities nationwide operating as designated guaranty agencies pursuant to the former program, which is now known as the Federal Family Education Loan Program (FFELP). The latter program is the William D. Ford Direct Loan Program (FDLP). Great Lakes Higher Education Guaranty Corporation (GLHEGC) is the designated guaranty agency under the Act for FFELP in Wisconsin, Ohio, Minnesota, Puerto Rico, and the Virgin Islands.

²Consolidation loans addressed by this article are limited to FFELP Consolidation Loans and FDLP Consolidation Loans (Federal Consolidation Loans or consolidation loans) authorized under section 428C of the Higher Education Act codified at 20 U.S.C. section 1078-3. Many law students and lawyers also may have nonfederally guaranteed student loans under various alternative loan programs (ALP) offered by lenders to supplement loans under the Act. Consolidation of ALP loans is offered by some lenders but is beyond the scope of this article.

³Borrower participation in the FFELP or FDLP is determined largely by the school a borrower attends. FFELP is the larger of the two programs and serves roughly two-thirds of borrowers nationally, including those at the U.W. Law School. FDLP services roughly one-third of borrowers nationally, including those at Marquette University Law School.

⁴Some lenders do not consolidate HEAL loans. Contact GLHEGC or your lender for more information.

⁵Consolidation is available earlier to FDLP borrowers or FFELP borrowers attending direct loan schools. Consolidating while in school may offer the opportunity to lock into the lower in-school interest rate.

⁶"Other education loans" are those made by an organization under a public or private student loan program exclusively to finance the borrower's post-secondary education. For the purposes of determining the borrower's repayment terms, the sum of the "other education loans" may not exceed the amount of the federal consolidation loan and may not include any non-Title IV education loans currently in default.

⁷Maximum repayment periods exclude authorized periods of deferment and forbearance.

⁸Income contingent repayment is offered only in FDLP and is not available for all loan types.

⁹Congress reauthorizes the programs under the Act every five years. These reauthorizations normally are the point at which major program evaluation and change occur. The 2003 reauthorization is anticipated to be the next time when review of federal consolidation loans may result in reconversion of the fixed rate interest formula to a variable rate.

¹⁰Consolidation loan volume in FFELP alone rose from 308,542 loans for $6 billion in federal fiscal year 2000 to 423,546 loans for $9.4 billion in federal fiscal year 2001.

¹¹The consolidation marketers specifically target recent graduates through direct mail and telemarketing campaigns to generate consolidation loans. Unlike many eligible lenders with long track records in student lending - many of which also offer consolidation loans - the marketers are newer industry entrants that are organized to specifically target the consolidation loan market as their principal business activity. In many cases they are buying mailing lists and/or existing borrower databases to enable their campaigns.

¹²The difference between the two loan types is that on subsidized loans the federal government pays the interest that accrues during deferment periods and grace periods, whereas the borrower is responsible for paying this interest on unsubsidized loans. Eligibility between the two loan types is based on need and loan limits.

¹³The rates are for loans disbursed on or after July 1, 1998. Loans disbursed on or after July 1, 1994 and before July 1, 1998 have add-ons of 2.5 percent and 3.1 percent for rates, respectively, of 4.26 percent and 4.86 percent.

¹⁴On Tuesday, May 7, 2002, the Federal Reserve Board's federal open market committee left the federal funds rate unchanged at 1.75 percent. The current reference rate set at the last auction in May 2002 was 1.76 percent. Readers can track future auction results at http://www.publicdebt.treas.gov/servlet/OFAuctions.

¹⁵Student loan borrowers can receive extended terms without consolidation for loans disbursed to new borrowers after Oct. 7, 1998. If their balances exceed $30,000, they are eligible for extended repayment, up to 25 years, without consolidating.

¹⁶Various borrower benefit programs are applicable from time to time in FDLP through the U.S. Department of Education. For example, through Sept. 30, 2001, borrowers who consolidated by FDLP could receive a 0.80 percent interest rate reduction if they made their first 12 loan payments on time, not more than six days after the scheduled payment date. FDLP can only offer a standard benefit for all consolidation borrowers. Eligible lenders offering FFELP consolidation loans may offer varying incentives that equal or exceed FDLP's interest rate reduction. Because FFELP borrower benefits vary from lender to lender and change often, borrowers should contact lenders directly to review current benefit offerings on consolidation loans.

¹⁷The Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16, signed June 7, 2001) prorated deductibility in these ranges. Below these ranges, deductibility is 100 percent subject to cap. For additional information, visit the IRS Web site at www.irs.gov and seek out Publication 970, Tax Benefits for Higher Education, http://ftp.fedworld.gov/pub/irs-pdf/p970.pdf.

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