Are There Loop Holes?
Single Holder Rule
The single holder rule is an anticompetitive rule that limits a student's choice of lenders for consolidation. If all of a student's FFELP loans are with a single lender, they must consolidate with that lender. If the student has FFELP loans with more than one lender, they can choose to consolidate their loans with any lender.
The early repayment status loophole also limits competition, because the holder of a continuing student's loans is under no obligation to grant early repayment status. If the holder refuses to grant early repayment status, it would appear that the student cannot consolidate with a different FFELP lender.
Bypassing the Single Holder Rule
There are a variety of loopholes that allow a student to bypass the single holder rule. Some of the following loopholes have not yet been confirmed as valid by the US Department of education.
- If the borrower certifies that he/she has "sought and has been unable to obtain a consolidation loan with income-sensitive repayment terms" from the holder of his/her loans, the borrower can consolidate with any lender. (HEA Section 428C(b)(1)(A))
- If the borrower is "unable to obtain to obtain a consolidation loan with income-sensitive repayment terms acceptable to the borrower", the borrower can consolidate with the Federal Direct Consolidation Loan program. Even if the holder of the loans offers income-sensitive repayment terms, the borrower can consolidate with Federal Direct Consolidation by certifying that the income-sensitive repayment terms are not acceptable. (HEA Section 428C(b)(5))
- If the borrower is still in school and has remaining Stafford Loan eligibility, the borrower can obtain a Stafford Loan from a different lender. (The single holder rule only limits a borrower's ability to choose a consolidation lender. It does not limit a borrower's ability to choose a different Stafford loan lender.) As soon as the borrower has FFELP loans with more than one lender, the single holder rule no longer applies.
- If the borrower consolidates a Perkins Loan into a FFELP consolidation loan with a different lender, the single holder rule no longer applies. (Dear Partner Letters FP-04-06, FP-04-05, and FP-04-02)
- Married students with loans from different lenders could bypass the single holder rule by consolidating their loans together. We do not recommend that married students consolidate their loans together. The ability to do this was repealed effective July 1, 2006.
If a continuing student wishes to take advantage of the early repayment status loophole, but the current holder of the loans does not cooperate, there are several possible loopholes that may allow the student to bypass this restriction. Some of the following loopholes have not yet been confirmed as valid by the US Department of education. (The early repayment status loophole was closed by the Deficit Reduction Act of 2005, effective July 1, 2006.)
- If the student has loans with more than one lender, and any of the lenders grant at least one of the student's loans early repayment status, the student can consolidate any or all of their student loans, even those for which a lender is refusing to grant early repayment status. This is because the language in sections 428C(b)(1)(A) and 428C(b)(4) that restricts the ability of FFEL lenders to make consolidation loans is defined in terms of eligible borrowers and not eligible student loans. An eligible borrower is defined in 428C(a)(3)(ii) has being in repayment status, in the grace period preceding repayment, or a rehabilitated defaulted borrower. So if a student has at least one loan in repayment status, they are an eligible borrower, and can consolidate any or all of their loans.Note, however, that the regulations at 34 CFR 682.201(c)(i) indicate that a borrower is eligible to receive a consolidation loan if the borrower is in repayment/grace period on the loans being consolidated. One might argue that this regulation prevents this method of bypassing the early repayment status requirement by limiting the definition of eligible borrower. But the regulation only gives satisficing conditions for eligibility and not necessary conditions for eligibility. The wording in the regulations is "if the individual" and not "if and only if the individual". The regulation is indicating that if an individual satisfies these conditions, they are eligible. But it does not state that individuals must satisfy these conditions to be eligible, and one can rely on the wording in the law at 428C(a)(3)(ii) to consider a borrower to be eligible even if they are consolidating loans that are not in repayment status, so long as the borrower has at least one loan in repayment status.
The language in 428C(a)(3)(A)(ii) does not seem to require the loans in repayment status to be Stafford Loans. So a Perkins loan in repayment status might qualify a borrower as an eligible borrower, enabling the borrower to consolidate their loans despite a non-cooperative lender. Perkins Loans can be granted early repayment status because of 484(c)(4). Note that Perkins Loans are not sufficient on their own to bypass the single holder rule, as the language in 482C(b)(1)(A)(i) that defines the single holder rule talks about "multiple holders of loans under this part", where this part refers to Part B of the Higher Education Act. Perkins Loans are defined in Part E. However, the borrower could consolidate the Perkins Loan into a FFELP Consolidation Loan to bypass the single holder rule, or the borrower could indicate that he/she has been unable to obtain a consolidation loan with income-sensitive repayment terms from the holder of the loans selected for consolidation, and per 428C(b)(1)(A)(ii), consolidate with a different lender. Clearly, if the holder of the loans is refusing to grant early repayment status, the holder is also refusing to consolidate the loans, and thereby enables a third party lender to consolidate the loans of the eligible borrower. - The student can consolidate with Federal Direct Consolidation even if none of the student's loans are in repayment status, because the language in 428C(b)(5) is specified in terms of the word "borrower" and not "eligible borrower" and there is no context that would imply that the word "borrower" is telegraphing "eligible borrower". It is also clearly the intent of this paragraph that it not be limited to students who have one or more Direct Loans, so a borrower does not need to have at least one Direct Loan to consolidate with Federal Direct Consolidation.
After a borrower has consolidated with Federal Direct Consolidation, he or she can reconsolidate the direct consolidation loan with a FFELP lender. (Note: Reconsolidating the loan does not relock the interest rate under current law. This may change with reauthorization of the Higher Education Act.) Although one might argue that the borrower needs to have at least one unconsolidated FFELP loan to do this, the US Department of Education issued guidance in 2004 that stated that the Department would not enforce its interpretation of the single holder rule through September 1, 2005, or reauthorization of the Higher Education Act, whichever came first. (Dear Partner Letters FP-04-06, FP-04-05, and FP-04-02) One could also argue that the borrower becomes an eligible borrower through the Federal Direct Consolidation Loan, because 428C(a)(3)(B) cannot terminate a borrower's status as an eligible borrower because that status did not begin until after receipt of the consolidation loan. Although a Federal Direct Consolidation Loan does not normally qualify to bypass the single holder rule, the consolidation loan in this case was made under the authority of 428C(b)(5) and so qualifies as being received "under this section". Alternately, the borrower could exploit 428C(b)(1)(A)(ii) to consolidate the Federal Direct Consolidation Loan, arguing that the borrower is unable to obtain a consolidation loan with income-sensitive repayment terms and so can consolidate the Federal Direct Consolidation Loan with any lender. (Technically, the Federal Direct Consolidation Loan offers income-contingent repayment terms, not income-sensitive repayment terms.) Alternately, the US Department of Education indicated in Dear Partner Letter FP-04-07 that it would allow FFEL consolidations for borrowers who are consolidation only a Direct Consolidation Loan or who are consolidating only a Direct Consolidation Loan and a Perkins Loan.
Once the Federal Direct Consolidation Loan has been consolidated into a FFEL Consolidation Loan, the single holder rule no longer applies. (The US Department of Education has issued guidance that indicates that lenders may not penetrate the veil of a FFEL consolidation with regard to the single holder rule. The mere existence of a FFEL consolidation is sufficient to bypass the single holder rule, regardless of whether the loans included in the FFEL consolidation loan would have been sufficient to bypass the single holder rule.)
Caveats
Some of the loopholes described have not yet been confirmed as valid by the US Department of Education.
Do not recommend consolidating a Perkins Loan while the borrower is still in school, because the borrower then loses the subsidized interest and the 9 month grace period. (If, however, the borrower requests early repayment status, the borrower loses the grace period but not the subsidized interest.) However, if the borrower needs to consolidate a Perkins Loan in order to bypass a lender who refuses to grant early repayment status, it is financially worthwhile to do so if the Stafford Loan balance is significantly greater than the Perkins Loan balance (i.e., at least 2-3 times greater). The borrower should consolidate the minimum amount of Perkins Loans necessary to bypass the single holder rule, and only pursue this if the borrower has a significant level of Stafford Loans (i.e., more than $7,500).
A married couple can consolidate their loans together to bypass the single holder rule if their loans are with different lenders. This is also an effective means of bypassing a lender that refuses to grant early repayment status to one of the couple's loans. However, FinAid does not recommend doing this, as the loans cannot be separated if the couple subsequently gets divorced. The couple will remain jointly and severally liable for the repayment of the consolidation loan. If the couple is undergoing an acrimonious divorce, the last thing they need is to provide each other with a tool they can use to ruin each other's credit ratings.
PLUS Loan Rate Loophole
With the PLUS Loan Interest Rate Loophole, you can use consolidation to reduce the interest rate on 8.5% fixed rate PLUS loans by 0.25%. The Higher Education Reconciliation Act of 2005 increased the interest rates on PLUS loans starting July 1, 2006, to a fixed rate of 8.5%, but left the interest rate formula on consolidation loans unchanged. In particular, it left the cap at 8.25%. So a PLUS loan borrower can reduce the interest rate on a PLUS loan by 0.25% simply by consolidating it, so long as the PLUS loans are consolidated by themselves.
You don't want to include other types of loans in the consolidation loan because the weighted average will reduce the interest rate before applying the cap. Consolidating PLUS loans by themselves maximizes the impact of the 8.25% cap.
There are no reasons why you can't consolidate a PLUS loan, so borrowers of 8.5% fixed rate PLUS loans may wish to consolidate them to reduce the interest rate. Parents of undergraduate students will be able to consolidate them soon after the PLUS loan is fully disbursed. Graduate and professional students, however, will need to wait until they graduate to consolidate, since in-school consolidation was repealed effective July 1, 2006. Since PLUS loans do not have a grace period, there is no reason to not consolidate them.
There is, however, a caveat. Often lender discounts on consolidation loans are inferior to the discounts on unconsolidated loans. So before you consolidate a PLUS loan to reduce the interest rate to 8.25%, compare the discounts you will be getting from the originating lender and the consolidating lender. If the originating lender has already discounted the interest rate below 8.25% without requiring prompt payment or automatic payment, it might be better to stick with an unconsolidated PLUS loan.
Grace Period Loophole
Students who consolidate during the grace period lose the remainder of the grace period. Consolidation loans do not have grace periods, so the consolidation loan enters repayment within 60 days. This section of FinAid discusses a loophole that may be exploited to retain most of the grace period if the lender cooperates.
If the lender delays disbursing the consolidation loan until the end of the grace period, however, the student gets to retain most of the grace period. (This loophole is also known as the "delayed disbursement" loophole.)
For borrowers with variable rate loans, guidance published by the US Department of Education (Dear Colleague Letters FP-06-09 and GEN-05-08) indicated that lenders can choose the interest rate in effect when the lender received the student's "substantially complete" consolidation application or when the lender disbursed the loan, whichever is lower. This allows the borrower to lock in a lower interest rate while still retaining the grace period. For example, if the student submits the consolidation application before July 1, and the lender disburses the payoff amounts to the current holders of the student's loans at the end of the grace period, the student gets to lock in pre-July 1 interest rates and also retain the remainder of their grace period.
(The Department's guidance is based on ambiguity in the Higher Education Act regarding whether the interest rate on a consolidation loan is based on the interest rates in effect when the borrower applies for the consolidation loan or when the lender disburses the consolidation loan. The repayment obligation begins within 60 days of the disbursement of the consolidation loan, per 428C(c)(4).)
Interest Rate Loophole
This section discusses a loophole that gives students who consolidate their loans before they enter repayment an effective interest rate reduction of 0.5% to 0.625%. With the switch from variable rate loans to fixed rate loans for new loans first disbursed after July 1, 2006, this loophole has been rendered ineffective for new borrowers. With new Stafford loans, the same interest rate is in effect during the in-school, grace and repayment periods.
When a student consolidates his or her loans, the weighted average of the interest rates is rounded up to the nearest 1/8th of a percentage point. A key consideration, however, is which interest rate is rounded up. If the student consolidates his or her loans before entering into repayment, the interest rate used is the in-school rate, which is lower than the rate used during repayment.
This loophole is clearly documented in the Federal Register, as excerpted below, and has been confirmed by direct communication with the US Department of Education. It is also mentioned in the "Dear Colleague" letter "GEN-99-17" and Direct Loan Bulletin "DLB-99-37", both of which incorrectly state that the benefit is available only to the Direct Consolidation Loan Program. Lenders are required to certify consolidated loans at the in-school rate if the application was submitted before entering repayment (e.g., during the in-school, grace or deferment periods), regardless of whether the loan is being consolidated into the FDSLP or FFELP programs.
The current in-school and repayment variable rate formulas are pegged to the 91-day T-bill rate plus margins of 1.7% and 2.3%, respectively. This yields a difference of 0.6%. Depending on the 91-day T-bill rate and the effect of the rounding, this can lead to an additional difference of -0.10% to 0.025%. Thus the total difference in interest rates for consolidated loans ranges from 0.5% to 0.625%. For example, in the 2000-2001 school year the in-school rate was 7.59%, and the repayment rate was 8.19%, a difference of 0.625% after rounding to the nearest 1/8th of a percent.
The savings over the lifetime of the loan can be substantial. The following figures assume an in-school rate of 7.625% and a repayment rate of 8.25% after rounding, and hence a difference of 0.625% in the interest rates. For a 10 year loan, this is equivalent to a savings of $39.62 per $1,000 borrowed over the lifetime of the loan. For a 15-year loan the savings increase to $64.84 per $1,000 borrowed. For a 20-year loan, $93.17 per $1,000 borrowed. For a 25-year loan, $123.34 per $1,000 borrowed. For a 30-year loan, $156.16 per $1,000 borrowed. Thus this will save students hundreds or even thousands of dollars over the lifetime of their loans. For example, a student who has $16,000 in loans and consolidates at the in-school rate for a 25-year term will save $1,982.71 over the lifetime of the loan.
It is worth noting that consolidating a loan locks in the interest rate for the lifetime of the loan. This is in contrast with unconsolidated loans, which use a variable rate that changes each July 1. Thus a student who intends to consolidate his or her loans should preferentially consolidate before entering repayment, in order to lock in the lower interest rate.
If a borrower's application is received before the student graduates or drops below half-time, the borrower automatically receives their six month grace period. (The US Department of Education has confirmed this for the Direct Loan Consolidation Program. It probably also applies for FFELP loans.) Nevertheless, we recommend that students who intend to consolidate before their loans enter repayment do so no later than the third or fourth month of their grace period, to ensure that the certification occurs before they enter repayment.
Students at Direct Loan schools can consolidate while they are still in school to lock in the lower in-school rate, in addition to during the grace period. (This provision was repealed effective July 1, 2006.) Students with bank-based loans from the FFEL program, however, can only lock in the lower in-school rate during the grace period, since they cannot consolidate while they are still in-school. (Students in the FFEL program who have at least one Direct Loan, however, may obtain a Federal Direct Consolidation Loan, and use it to lock in the lower in-school rate before graduation.) However, a loophole discovered in 2005 allows students in the FFEL program to request early repayment status while they are still in school. This allows them to consolidate while they are still in-school. If they ask for an in-school deferment after receiving early repayment status, the loans will be consolidated at the in-school rate. (This loophole was closed effective July 1, 2006 by the Higher Education Reconciliation Act of 2005.)
Treatment of Interest Rate Reductions
Another issue is how the weighted average of the interest rates is affected by incentive programs such as interest rate reductions for prompt payment. The Federal Register excerpt does not explicitly state whether it is the "applicable rate" or the "actual rate" as defined in the various statutes and regulations. The word "apply" suggests the former, while the word "current" suggests the latter.
However, the law is quite clear in describing the interest rate with respect to consolidation as an "applicable rate" and not an "actual rate". For example, 682.202(a) says that "The applicable interest rates for FFEL Program loans are given in paragraphs (a)(1) through (a)(4) of this section." Section 682.202(a)(4) describes the interest rates for consolidation loans, and in particular, 682.202(a)(4)(iv) describes the formula for calculating the interest rate on consolidation loans. In contrast, a description of actual interest rates is described in Section 682.202(a)(5), and explicitly refers to the rates in 682.202(a)(4) as applicable interest rates: "A lender may charge a borrower an actual rate of interest that is less than the applicable interest rate specified in paragraphs (a)(1)-(4) of this section." Thus it is clear that the interest rate used in computing the weighted average during repayment is theapplicable rate and not the actual rate, and so does not include any of the lender's voluntary interest rate reductions. The lender may, of course, choose to apply such prompt payment discounts and interest rate reductions to the loan after consolidation, as per 682.202(a)(5).
Excerpt from Federal Register
The following text is excerpted from the Federal Register, Volume 64, Number 210, dated November 1, 1999.
Comment: In response to the Secretary's request for comments on how to make these proposed regulations easier to understand, a major association representing credit unions suggested that for clarity, we provide an example to clarify the regulatory requirement to use weighted average interest rates for Consolidation loans.
Discussion: The weighted average interest rate used for Consolidation loans in both the FFEL and Direct Loan programs should be calculated based on the interest rates that apply to the loans being consolidated at the time the loan holders complete the verification certificates. In making the calculation, it is important to note that an interest rate that is lower than the repayment period rate applies to most subsidized and unsubsidized Stafford loans in the FFEL and Direct Loan programs during the in-school, grace, and deferment periods. This affects the calculation of the weighted average interest rate. If, for example, a loan is in a grace period at the time the loan holder completes the verification certificate, the lower grace period interest rate would be used in the calculation of the weighted average interest rate on the Consolidation loan. Conversely, if the borrower applies for a Consolidation loan after entering repayment on a loan, the higher repayment interest rate of the loan being consolidated would be used in calculating the weighted average interest rate on the Consolidation loan.
The weighted average interest rate is a single interest rate that is calculated by using the borrower's loan balances and the current annual interest rate for each of the borrower's loans.
For example: A borrower has two subsidized Federal Stafford Loans, one for $10,000 and the other for $5,000, both with an interest rate of 8.25 percent. The borrower also has a $3,500 unsubsidized Federal Stafford Loan with an interest rate of 7.46 percent and a $3,000 Federal Perkins Loan with a 5.0 percent interest rate. The borrower consolidates these loans.
The following steps outline one way to calculate the weighted average interest rate:
- Multiply the balance of each loan being consolidated by the interest rate that applies to that loan at the time the verification certificate is completed.
- Add the calculated interest amounts for all loans being consolidated ($1,648.60).
- Add the loan balances for all loans being consolidated ($21,500).
- Divide the sum of the calculated interest amounts by the sum of the loan balance amounts (7.66%).
- Round the quotient (the answer to Step 4) to the nearest higher one-eighth of one percent (7.75%).
- Compare the result in Step 5 to the 8.25% maximum interest rate and determine which is lower. The lower of the two rates is the borrower's fixed interest rate for the Consolidation loan.
Acknowledgments
Thanks to Phil Schrag, Bob Sandlin, and Karen Epps for help identifying and confirming this loophole.