Statement of Dr. A. Dallas Martin. Jr.
NASFAA President

U.S. House of Representatives
Subcommittee on 21^st Century Competitiveness
Committee on Education and the Workforce

Consolidation Loans:  What’s Best for Past Borrowers,
Future Borrowers, & U.S. Taxpayers?

July 22, 2003

Mr. Chairman and members of the Subcommittee on 21^st Century Competitiveness, I thank you for the opportunity to testify today on student loan consolidation. I am Dallas Martin and I am the President of the National Association of Student Financial Aid Administrators (NASFAA). Formed nearly forty years ago, NASFAA represents student financial aid administrators at nearly 3,100 postsecondary institutions across the nation.

Our association illustrates the diversity of our higher education enterprise with members from private and public institutions, community colleges, four-year schools, proprietary schools, and graduate/professional institutions. At these schools, NASFAA represents approximately 9,300 financial aid professionals whose passion is ensuring that talented Americans have the opportunity to attend a postsecondary institution by providing counseling and financial resources.

NASFAA submitted to the Committee its recommendations for reauthorization of the Higher Education Act of 1965, as amended. We believe this comprehensive set of over 100 individual recommendations will go a long way in providing the necessary structure to ensure and extend educational opportunities for our citizens, to target and retarget scarce taxpayer funds in an era of budget deficits, to appropriately deregulate and simplify the financial aid system, to encourage innovation, to reform Title IV programs so that entities do not have unfair competitive advantages, and to assist borrowers by providing both enhanced consumer protections and benefits.

In crafting reauthorization proposals, NASFAA took seriously its obligation to make recommendations that are unambiguously focused on students and educational opportunity. Our recommendations, taken as a whole, set a high standard for you to meet. That high standard, however, will assure a whole range of positive outcomes, especially making certain that no child will be left behind from attaining their dreams for their future and family because of a lack of the financial resources to attend a postsecondary institution appropriate to their talents and drive.

To not meet this high standard will, in our view, put at risk our system of postsecondary education that serves well so many individuals of limited economic means and will put at risk the ability of students to gain the skills necessary to keep American business and industry competitive and at the forefront of innovation in our world economy.

NASFAA welcomes today’s hearing on federal loan consolidation and we support the continued availability of the benefits of loan consolidation for those former students who need it.

In supporting loan consolidation, Mr. Chairman, NASFAA should not be seen as supporting all of the developments of the past two years associated with this program. In fact, many NASFAA members are very concerned by the explosive growth in the number and dollar volume of consolidation loans. Our members are also concerned that the focus of Congressional discussions of student loan issues appears to be shifting from students to former students.

As you know, a number of bills on loan consolidation have been introduced recently. We also are aware of numerous articles in the media all dealing with loan consolidation. It is truly unfortunate that other urgently needed changes in this reauthorization legislative process are not receiving the same attention. For example, we are not reading about the need to repeal borrower-paid origination fees or to provide other necessary and beneficial changes in the student loan programs; we don’t hear much discussion about the grant programs or important other reauthorization issues. What we do hear loudly and clearly are arguments, some of them disingenuous and some of them off the point, about the need for "competition" in the consolidation loan marketplace.

Indeed, our first panel evidences the deep and sincere Congressional interest in extending loan consolidation. Controversy surrounds this matter, as you know. Just last year the White House surfaced a loan consolidation proposal, but withdrew it under intense political pressure. Some possible solutions being considered in this area will certainly help former students who are federal loan borrowers, but NASFAA strongly believes that some of those solutions will consume scarce federal monies that are better expended assisting current and future students. Further, some solutions actually will disadvantage borrowers and have unintended consequences.

We understand that the principal motivation for the interest of many members of this committee in loan consolidation is the increased student debt burden faced by many students and former students. We urge you to look at NASFAA’s related recommendations on this subject. We endorse increased grant assistance and increased authorizations for the Title IV campus-based grant and Federal Work-Study programs; reform of loan repayment options that have not been significantly changed in a long time; an add-on payment for the neediest of Pell-eligible students who have a negative Expected Family Contribution (EFC); changing the student interest deduction to a refundable tax credit to help reduce student debt; and, making the Federal Pell Grant Program a true entitlement. If the goal of this subcommittee is to address student and borrower debt burden, these topics should be on the table and acted upon.

The amount of loan consolidation has risen to unprecedented levels. More than $32 billion consolidation loan volume was realized in 2002, double the amount in the previous year and double the level of the year before, according to The Chronicle of Higher Education. This volume results not only from the opportunities created by the current extraordinarily low interest rates, but also as a result of aggressive and, in our view, sometimes inappropriate marketing efforts.

Financial aid administrators report they have never seen the amount of loan consolidation marketing aimed at borrowers, their families, and, it almost seems, everyone in America. Some of my staff report they have been targeted multiple times with loan consolidation marketing letters and telemarketing phone calls even though they and their children have graduated from college and paid their student loans in full years ago.

Sadly, I must report that a number of these firms eager to sign up loan consolidation borrowers paint the most positive picture, but neglect to tell the whole story. These rosy scenarios tell borrowers that they can lock-in low interest rates and by using other benefits such as making a certain number of on-time payments or using electronic payment methods, borrowers can receive even lower interest rates. While many firms do caution potential loan consolidation candidates on the possible downsides to loan consolidation, others are less than forthcoming with consumer information or do not inform consumers about the "Catch 22s" of their plans.

Some loan consolidation firms give a hard sell to former students telling them that they can reduce their monthly payments by tens or hundreds of dollars and get an unbelievably low interest rate. These firms soft pedal information or, in some cases, do not disclose at all that the borrower’s overall debt will climb by hundreds or thousands of dollars, even double or triple what they would have paid compared to maintaining a standard ten-year repayment plan.

Some firms using the current low rate compare the amount saved by loan consolidation to the statutory 8.25 percent interest rate cap thereby inflating such "savings." Some firms, but not all, will suggest that the low interest rate can be reduced even further by offering on-time payment or electronic checkbook deduction benefits, but do not disclose that few borrowers ultimately qualify for such benefits. When one examines the fine print of on-time payments and electronic transfers of loan payment benefits, then all too often the restrictions are so extensive that for most borrowers, such benefits evaporate. For example, some firms tout the fact that former students in their loan consolidation program can prepay their loans, that all prepayments reduce principal, but neglect to say that a prepayment violates their on-time payment standard and, therefore, a prepayment makes one ineligible for their on-time interest rate reduction benefit. One would think the combination of on-time payment and use of electronic payments from a checking account is unbeatable; however for some firms, if a borrower’s checking account does not have sufficient funds in a single month to cover the consolidation loan payment, that overdrawn account make the borrower ineligible for both the benefits of on-time payment and electronic debit of a checking account.

Finally, we find poor consumer information regarding some of the other downsides of loan consolidation. Some firms will suggest in their marketing that borrowers retain their federal loan benefits such as deferment, forbearance, and student loan interest tax deduction. They understate or, in some cases, do not disclose at all—especially if Perkins Loans are included in consolidation—that certain benefits such as loan cancellation for teachers or nurses or other similar cancellation benefits are lost if one decides to consolidate. Some gloss over the fact that lender-provided benefits are not offered by certain loan consolidation firms. Some soft pedal the idea that interest-free grace periods may be lost. I am not suggesting that the entire loan consolidation industry either uses or condones such practices, but enough do so to be problematic.

A number of you will suggest that we can fix these problems. Perhaps you can, but federal student aid history is replete with examples of solutions that don’t work; that are overly burdensome; that are inappropriate; that can be circumvented; or that are not enforced by federal authorities. What I believe needs to be accomplished in the area of loan consolidation is for the Congress to reassert historical first principles back to when loan consolidation was initially authorized.

You all know that in making changes to the Title IV student aid programs, you need to make choices. And, it is true that in making choices, especially in an era of scarce resources, certain decisions will enhance educational opportunities for our citizens and other choices, however well-meaning, will benefit some individuals, but not extend other benefits that are more important to the greater population of students. Your decisions on loan consolidation are choices that underline that distinction.

Our proposal recommends that the law dealing with loan consolidation revert back to first principles. When loan consolidation was first enacted, its purposes were twofold. First, loan consolidation was intended to help borrowers who had multiple loans from multiple holders gain a single payment to reduce the confusion of writing several checks each month to lenders. Second, and partially an outgrowth of the first reason, was to curtail defaults by reducing monthly debt burden. Borrowers who were unable to make monthly payments could avoid default by consolidating their loans to stretch out the repayment time period and receive the benefit of lower monthly payments.

It is time to return to those purposes. Nowhere in the 1980’s congressional debate was it contemplated that loan consolidation would be used as a refinancing mechanism. In fact, the original loan consolidation program carried an interest rate that was one percent higher than that imposed on non-consolidated loans. At that time, the interest rate charged on consolidated loans was set by law at the higher of 9 percent or a weighted average of the interest rates on loans being consolidated (rounded to the nearest whole percentage rate). And, I must state that those original purposes successfully assisted in the reduction student loan defaults and the burden on borrowers with impossibly high monthly payments. We should return to those original purposes for several reasons.

In my mind, the most important reason for returning to first principles comes back to my earlier remarks about choices. To retain a consolidation loan program that can be used as a refinancing tool or to expand refinancing options will cost the government large amounts of resources. If we had unlimited money, I might recommend what the witnesses who spoke before me and others suggest in the area of loan consolidation. But we don’t have unlimited resources and so you must make choices. And, the choice I urge you to make is to spend those limited resources—any new funding or retargeted funding that you might have in this Higher Education Act reauthorization—on expanding educational opportunity for current and future students.

NASFAA has made numerous recommendations to help ensure that each American is not denied their dreams through attainment of a postsecondary education due to a lack of funds and we urge your serious consideration of them. Among our recommendations are several that retarget funding or even deny current federal aid to certain individuals. As to loan consolidation, we recommend the committee reform the loan program repayment options. We believe our recommendations will not only make loan repayments easier for those who need relief, but also will eliminate the need for loan consolidation except in very limited circumstances.

The choice I urge you to make is to use those resources for individuals who are seeking or continuing their education. I believe that the wisest use of limited funding is to expend it on better student aid programs and funding at the front end of the educational process for current and future students and not at the back end upon individuals who have already been amply assisted, have successfully completed their schooling, and are gainfully employed and enjoying all of the benefits that accrue to them because thy were provided an educational opportunity.

Our members are also perplexed that some individuals suggest that federally-subsidized consolidation loans are "just like home mortgages." Obviously, in one case the person has a tangible, physical asset and in the other an intangible one; an education cannot be repossessed. Let us take a closer look at the government subsidies. When one refinances a mortgage to lower the interest rate and monthly payment, the federal subsidy (the mortgage deduction on your Form 1040) goes down. When one consolidates federal student loans, one receives a lower interest rate and monthly payment, but extends repayment by up to an additional 10 to 20 years over the standard 10-year repayment plan. The interest rate tax deduction goes down, but federal loan subsidies substantially increase. While most mortgages are not directly subsidized by the federal government, student loans are directly subsidized and that is the critical difference between student loan consolidation and home mortgages. For example, an undergraduate student who borrowed $17,000 receives approximately $700 in subsidies over a 10-year Stafford repayment term and roughly $4,200 in subsidies over a 15-year consolidation repayment term. The average subsidies for a professional school graduate with a $73,500 loan balance would be $3,100 over a 10-year Stafford repayment term, as compared with $36,500 for a 30-year consolidation repayment term.

Again, I come back to my earlier point: "Is it better economic policy to expend scarce tax dollars to help subsidize future needy students or to give even more subsidies to former students?" This public policy issue, in my mind, is very clear. One is a good investment for our future and the other is a needless investment.

To retain loan consolidation as it currently exists has other ramifications, all of them negative. Borrowers who consolidate loans with repayment periods out to 30 years will repay a total student loan amount of up to double or triple what they would have paid if they had retained the standard 10-year repayment. They are not going to have as much disposable income. They will not have the funds to buy the home of their dreams, automobiles, or other consumer durable goods. Worse than that they are not going to be in a good financial position to save money for their retirement or contribute as much as they might to their children’s postsecondary education or be in a position to utilize PLUS loans for their child’s education. These are serious considerations for you to ponder; the ramifications of loan consolidation go well beyond the effects on borrowers, lending institutions, and the federal government.

Some have suggested that a market-based solution to loan consolidation is appropriate and that all we need to do is repeal the "single holder rule." Proponents argue that repeal of the single holder rule will open the market up to competition.

NASFAA opposes repeal of the single holder rule for several reasons. First and foremost, we believe that repeal of the rule will destabilize the student loan system and, thereby, reduce competition. Repeal of the single holder rule will allow any lending entity to market its loan consolidation product to any borrower. What is wrong with that you may ask? The answer is that lenders determine their participation in the federal loan program by anticipating a certain amount of profit depending on their business plans. Some merely originate loans and, then, turn around and sell them. Some hold the loans and service them for the entire length of the loan. If a borrower can consolidate loans with any entity that successfully markets the former student, then the first holder must relinquish the loan. At that point, the original lender—having lost its loan—will not meet its projected revenue goals. So what is that lender to do if it cannot meet such revenue goals? We suggest that no rational business plan can be constructed to meet such an eventuality and, consequently, such a lender would have no alternative but to stop making student loans altogether. We believe this is not only a real possibility, but one that will quickly become a reality leading to massive disruption and instability in the student loan marketplace.

And, stemming from this fact, let me state my serious doubts that any lending entity involved in loan consolidation from the most reputable to the least caring about borrowers would support a change in the law that would allow any borrower to refinance their consolidation loan once or again and again (reconsolidation). My educated guess is that they would support continuation of current law providing that loan consolidation can only occur once. To allow multiple refinancing, as is true in the case of home mortgages, would financially devastate such loan consolidation lenders. Certainly, the generous add-on benefits would be eliminated.

The second effect comes directly from the first one. If fewer lenders participate in the student loan market, then, naturally, the industry will become more concentrated. The student loan industry is already highly concentrated with a few giant lenders dominating the field. NASFAA has no doubt that a concentrated industry obviously leads to less, not more competition. Fewer competitors mean students have fewer choices in lenders.

In sum, we believe that repeal of the single holder rule will lead to an undesirable destabilization of the loan industry, to less competition and greater concentration in the industry, and, eventually, to greater disparities in borrower benefits and the services offered by the industry. We strongly urge no change in this matter.

Another issue associated with loan consolidation relates to the application of the "single holder rule" with regard to Federal Perkins Loans. NASFAA recommends a clarification so that it is clear that Perkins Loans may continue to be eligible for inclusion in a consolidation loan, but are not treated as a separate "loan holder" to get around the single holder rule. Some loan consolidation firms, in our view, have been violating the law and circumventing the single holder rule by claiming a Perkins Loan held by a school is therefore a separate holder. Consequently, such firms have been consolidating loans in violation of the single holder rule. We believe a clarification is necessary.

NASFAA recommends that the student interest rate on all Stafford Loans, including consolidation loans, be changed from a fixed to a variable rate. We understand this position is an evolution in our thinking since we joined with our sister associations in opposing the Administration’s proposal to implement a variable rate loan last year. But, in rethinking the whole issue of loan consolidation and student loan interest rates we have come to the conclusion that consolidation loan interest rates should parallel regular Stafford Loans.

We note that P.L. 107-139 signed by the president last year mandates that student loan interest rates rise to a 6.8 percent fixed rate on July 1, 2006. NASFAA supported this legislation; however, we proposed then that the interest rate cap be lowered to 6.8 percent and that loans continue to have a variable rate instead of retaining a 6.8 percent fixed rate. That continues to be our reauthorization proposal. We suggest to the subcommittee that the subject of interest rates is an important one. We are concerned about the difficulties associated with moving to a higher fixed rate if the current low student loan interest rate environment (now at 3.42 percent) continues until 2006. Of course, if the July 1, 2006 increase to a 6.8 percent fixed rate is not changed, then eventually even consolidation loans will carry such a rate making moot today’s controversies on loan consolidation. Finally, if consolidation loan interest rates are changed to variable ones and Stafford Loan interest rates are maintained as variable, then the only reason for consolidating a loan is to get a single payment in the event of multiple loans from multiple holders or to extend the repayment time period to receive a lower monthly payment to avoid a default.

Mr. Chairman and members of the subcommittee, NASFAA has recommended two other loan consolidation related changes in the Higher Education Act. To reduce loan consolidation costs to the government, we recommend consideration of a "loan consolidation fee." We have not recommended the amount of the fee or the nature of such a fee, i.e. a percentage or flat figure. Second, as part of a comprehensive set of recommendations to level the playing field between the loan programs, NASFAA suggests there is not a need in either FFELP or Direct Loans (DL) for an in-school consolidation benefit and so would eliminate it from the DL program.

As I referenced earlier, some would suggest that increased student consumer information requirements be mandated for consolidation loans. NASFAA does not believe this is a wise decision. Consumer information disclosures on loan consolidation are included in the counseling requirements that schools and others are required to perform. Financial aid administrators are already diligently helping former students who seek information on loan consolidation and they assist thousands in making informed decisions on whether to consolidate or not consolidate their loans. I must frankly state we are doing as much as we can to inform and provide educational materials to our students and former students. Financial aid administrators know that providing excellent counseling is one of their primary jobs. We oppose any further extension of loan counseling activities or mandates since they would be duplicative of current legal requirements.

In conclusion, Mr. Chairman and members of the subcommittee, NASFAA urges you to put the consolidation issue into the context of the purpose of the Higher Education Act: to create educational opportunity. We urge you not to spend scarce federal budget resources on former students, especially in a program that is not need-tested or even targeted to needy individuals. Every dollar spent on loan consolidation is one less dollar that can be spent on needy students.

Thank you for the opportunity to testify here today. I look forward to working with you, Mr. Chairman, and all members of the subcommittee to reauthorize a Higher Education Act that meets the needs of students, their families, and all of the parties involved in the delivery of student aid dollars in this nation. I hope that those of you who have not yet reviewed NASFAA’s Higher Education Act reauthorization proposals will do so by visiting http://www.nasfaa.org/publications/2003/gnasfaadetailedreauthrecs070903.html

I would be pleased to respond to any questions you may have.