Low rates on student-loan consolidation spell opportunity

By Ray Martin, CBS.MarketWatch.com

BOSTON (CBS.MW) -- College grads, former students and their parents with education loans have what may be one of the best opportunities to save real money. Through a loan consolidation they can dramatically lower their monthly payments by refinancing their variable-rate student loans into a single loan and lock into one of the lowest fixed interest rates seen in generations.

By doing so, they can also free up cash to pay down credit card debt, save for a home or begin building a retirement nest egg.

At the center of this opportunity this year is the interest rate that applies to a consolidation loan, which is a fixed rate that replaces the variable rate of the existing student loans.

Under a federally subsidized program, in July of each year the Department of Education sets the fixed rate for the following 12 months. The fixed rate is tied to an index of the 91-day Treasury bill rate as of the end of May each year for all loans consolidated during the 12-month period.

In May, the T-bill rate hit a low of 1.07 percent, which means that the fixed rate that applies loans consolidated between July 2004 and June 2005 will be 3.37 percent for Stafford Loans and 4.17 percent for PLUS Loans, for the life of the loan. That's a bargain when you consider that the variable rates for Stafford loans that are not consolidated can adjust to a maximum of 8.25 percent and up to 9 percent for PLUS loans -- which is about where variable rates for these loans were just five years ago.

The only cost to consolidating student loans is that the interest rate for the consolidation loan is rounded up to the next highest one eighth of a percentage point.

For example, if the weighted average for your loan rates to be consolidated is 3.39 percent, the consolidation rate will be 3.5 percent, which could add an additional buck or two per month to your current payment. But you will have peace of mind knowing that the interest rate is fixed for the life of your loan.

According to a survey by Nellie Mae, a leading provider of federal and private education loans, 55 percent of borrowers said they felt burdened by their student-loan payments. That's not surprising with the average graduate leaving public school owing over $17,000 and making payments on six to eight loans -- and owing over $3,200 on credit cards.

Who should consolidate?

Not all student loans should be consolidated, for example federally subsidized Perkins loans. That's because the benefit of government loan forgiveness for Perkins borrowers who later enter qualifying teaching, law enforcement or military service will be lost when those loans are consolidated.

Also, loan consolidation is probably not for active students whose loans are in a grace period, where payments are not required until six months after graduation, because loan consolidation triggers the requirement to make loan payments.

But recent grads with loans in a grace period do have a special opportunity: those who consolidate their loans during the grace period can lock in an even lower fixed rate of 2.77 percent (rounded up) versus 3.37 percent.

Some loan providers, such as Sallie Mae, will allow you to apply for consolidation while in a grace period and delay processing your loans until the end of your grace period. With others, you can wait until near the end of the grace period to apply and still get the lower rate.

With interest rates this low, and very likely to begin a period of rising, it's a safe bet that rates for consolidation loans will be higher when reset next summer.

Also, Republicans in the House of Representatives have introduced legislation that proposes to end the fixed-rate loan-consolidation program. The legislation proposes that all loans in the future have variable rates so that all current and former students pay the same interest rates.

Advocates of the proposal say that it's unfair that students who are lucky enough to graduate when interest rates are low get to consolidate and lock in low rates that are subsidized with government funds while tomorrow's students are forced to borrow at variable rates that rise in the future.

How and where to consolidate

Since loan consolidation is allowed only once, you have to consider your options carefully. And even if you have only one loan, you can use consolidation just to lock in the low fixed rate.

You have to first contact the companies that service your loans because the program requires that you work with their loan-consolidation product first. If you have loans through several providers, each should offer the interest rate set by the government rules but their terms and other valuable discounts can vary.

Some consolidation-loan providers will offer to reduce your interest rate by over 1 percentage point after you make the first 36 payments on time. Others offer cash rebates for those who make the first six payments on time.

Many providers offer to cut your rate by 0.25 percent if you sign up to automatically deduct loan payments from your bank account. There are no fees, credit checks or collateral required, so steer clear of any provider who states otherwise.

There are generally four options offered under the Direct Consolidation Loan Program:

Standard repayment plan: allows a fixed monthly payment for a maximum of 10 years.
Extended repayment plan: a fixed monthly payment ranging from 12 to 30 years, depending on the amount borrowed. The monthly payment will be smaller than the standard repayment plan, but you will pay more interest over the life of the loan.
Graduated repayment plan: monthly payments that start out lower and increase every two years, with repayment required over 12 to 30 years depending on the amount borrowed. The monthly payment will be even smaller, and will increase as your income increases. You will pay even more interest over the life of the loan versus the extended repayment plan.
Income contingent repayment plan: monthly payments are based on the borrower's income, family size and total loan amount and can be repaid over up to 25 years.
While loan consolidation seems like a no-brainer for those who qualify, the repayment plan requires a little more thought. When deciding, consider this advice:

Let's say your consolidated loan is $18,000, at a fixed rate of 2.875 percent. If you choose the standard repayment plan, for 10 years, your monthly payment will be about $173 and you will pay a total of $20,733 over the life of the loan.

Choose the extended repayment plan over 20 years and your monthly payment will be $99, or $74 per month lower. You will pay a total of $23,683 over the life of the loan, or about $3,000 more than the standard plan. Assuming you take some good advice and contribute the $74 per month into an employer's retirement plan, and your employer matches your contributions with an additional $37 a month, you could accumulate more than $51,000 after 20 years, assuming a six percent annual rate of return.

Doing the math, you could come out over $48,000 ahead. The same concept applies to paying down high-interest-rate credit card debt, which should be done before making any additional retirement-plan contributions in excess of that matched by an employer.

If later you income rises and there is cash flow a-plenty to save and invest, you can always pay off your student loans at any time, without penalty.







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