Time To Save On Student Loans

Former college students and their parents currently have what may be one of the best opportunities to save money on student loans.

At the center of this opportunity is anticipation that the interest rate that applies to consolidation loans – a fixed-rate loan that replaces the variable rates of the existing student loans – is set to rise this summer. To help you decide how to act, financial adviser Ray Martin visits The Early Show.

Under a federally subsidized program, every July the Department of Education sets a fixed rate that applies to consolidation loans for the following 12 months. The fixed rate is tied to an index of the 91-day Treasury Bill rate at the end of May each year. That rate is approximately 2.85 percent, which is over 1.75 percentage points higher than it was last year. This means that the fixed rate that applies to loans consolidated after June 2005 could be approximately 5 to 6 percent, versus 3.37 percent for Stafford Loans and 4.17 percent for PLUS Loans consolidated before July 2005.

Through a transaction called "loan consolidation," individuals with qualifying student loans can lower their monthly payments by as much as 50 percent, refinancing their variable rate student loans into a single loan and locking into one of the lowest fixed interest rates seen in a generation.

Students and parents who have education loans, such as Stafford loans and PLUS loans, can refinance, or consolidate multiple loans into a single loan, with a single lender, with a lower monthly payment, at a low fixed interest rate, that's good 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 six years ago.

The only cost to consolidating student loans is that the interest rate for the consolidation loan is rounded up 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.
Who Should and Should not Consolidate Loans?
Not all student loans should be consolidated. If you consolidate a Perkins loan, you lose the benefit of government loan-forgiveness for borrowers who later enter qualifying teaching, law enforcement or military service.

It was widely believed that loan consolidation was not allowed for active students whose loans are in a grace period, where payments are not required until six months after graduation. According to guidance released by the Department of Education on May 16, active students can apply to consolidate their existing loans, which then can be placed on in-school deferment status. Given the looming increase in the interest rate that applies to loans consolidated after June, students who are still enrolled may want to consider this option. Many lenders will allow active students to consolidate their existing loans and then place the consolidated loan on deferment, with payments to begin immediately after graduation. These deferred loans will carry a deferment interest rate which will be a higher rate, but still likely to be lower than future rates for consolidated loans.

Loan consolidation may not make sense for all actively enrolled students. Many lenders require a minimum total loan balance of $7,500 for consolidating loans, and students will lose the ability to consolidate all of their student loans into one loan after graduation. Students also will lose the six-month grace period for repaying loans after graduation, as payments on consolidated and deferred loan will be required to be made immediately after graduation.

But recent grads who have loans in a grace period 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.

Why Now?
With interest rates higher, it's a certainty that rates for consolidation loans will be higher when reset this summer.

Also, Congress has legislation that proposes to end the fixed-rate loan consolidation program as it exists today. The legislation proposes that all loans in the future have variable rates so that all current and former students pay the same interest rates on their loans. 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.

To find out how this works, 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, although each should offer the interest rate set by the government rules, but their terms and other valuable discounts offered can vary. Some consolidation loan providers will offer to reduce your interest rate by over 1 percent 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 .25 percent if you sign up to auto-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.

How Long To Repay?
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 for the first 24 months 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, total loan amount and can be repaid over up to 25 years.

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.

If the higher payment required to pay off your loan over 10 years cramps your cash flow, leaving nothing to pay down credit card debt, to save for a house, or to contribute to an employer's retirement plan, consider this instead:

Choose the extended repayment plan over 20 years; your monthly payment will be $99, or $75 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 this 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 a retirement plan account of over $51,000, after 20 years, assuming a 6 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 credit card debt. This should be done before contributing to any retirement plan other than those matched by an employer.

If later your income rises and your cash flow allows it, you can always pay off your student loans at any time, without penalty.