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Last chance to lock in dirt-cheap student loans

By Liz Pulliam Weston

Time is running out on borrowers’ ability to lock in low student loan rates.

Rates on federal student loans drop to record lows on July 1, which is great news for this year’s graduates and those who have yet to consolidate their loans.

But the Federal Reserve has clearly signaled that rate increases are coming. And even a 1 percentage point increase in the prevailing student loan rate can add $2,500 to the 20-year cost of the average graduate’s $20,000 loan burden.

What’s more, powerful lenders are pushing for a big change in the way consolidation loans work. If these lenders succeed -- and the odds are with them -- interest rates on future consolidations will be variable, rather than fixed, starting in July 2006. (Loans consolidated before then would not be affected.)

The proposal could add considerably to the cost of getting an education. The nonpartisan Congressional Research Service estimates variable rates on consolidated loans could add $3,000 to $5,500 to the average loan cost over 15 years. The U.S. Public Interest Research Group, a consumer advocate, thinks the potential cost could be closer to $8,000.

Those who can consolidate after July 1 could very well be taking a last-of-its-kind chance to lock in the lowest rates in the program’s 38-year history.

Consolidation, in case you’re not familiar with the process, is a way of bundling your federal student loans into one. The interest rate you’re charged on the consolidated loan is based on a weighted average of the underlying loans, rounded up to the nearest one-eighth percentage point.

The rate is locked in for the life of the loan, and you often have the choice of paying back the loan over a longer time period, depending on how much you owe.

You can consolidate with your current lender or with just about any other lender that specializes in federal student loans. If you're not sure who your lender is, you can use the lender locator at the National Student Clearinghouse to find out.

Here’s what’s important to know:

Don’t forget: Consolidation is a one-time deal. It’s possible, if unlikely in the near future, that rates could drop again. If that happens and you’ve already consolidated, you won’t be able to take advantage of that subsequent drop on your consolidated loans since your rate would be locked in.

The odds strongly favor of higher rates, however. We’ve been enjoying rates not seen for more than four decades, and some people expect to see student loan rates in the 6%-to-7% range before too long.

Give yourself maximum flexibility. The more you owe, the longer you can take to pay it back. Those who consolidate less than $7,500, for example, must pay back their loans in 10 years, while those who owe $60,000 or more have a choice of 10-, 12-, 15-, 20- or 30-year payback periods.

The longer the term you chose, the lower your monthly payments -- but the more you’ll pay in total interest. So savvy borrowers tend to choose the longest payback period available to give themselves more financial flexibility. They start with a low payment in case times get hard, but then they double or triple their required monthly payments whenever feasible to pay the loan off as quickly as possible.

Shop around. The feds set the general rules for loan consolidation, but some consolidators offer breaks that can significantly lower your costs. Many will knock a quarter-point off your rate if you agree to automatic deductions from your checking account. They’ll knock a full point off if you make on-time payments for a certain period. With some lenders, you get the break in as little as three years; others want four to five years of payments first.

(To check out student loan companies, check out the sites listed at left under Related Sites.)

Federal student-loan rates are based on the yield of the 91-day Treasury bill, as measured on the last business Monday in May. (Because of the Memorial Day holiday this year, Monday, May 24 was used.) The new rates are applied to all outstanding variable loans on July 1.

The three-month Treasury is one of the rates that will quickly reflect any changes the Fed makes to short-term rates. By the next time the Department of Education adjusts rates in July 2005, most economists are betting student loan costs will be at least slightly higher.

Your best strategy now depends on where you are in the borrowing cycle.

Still in school
Unfortunately, you typically can’t consolidate before you graduate. (Graduate students can consolidate their undergraduate loans, but then they have to start making payments, which may not be economically feasible.) Your best move now is to limit the amount you borrow as much as you can.

Take a look at my article “How much student loan debt is too much?". Then, consider alternatives if your debt load is getting dangerously high. That can include taking a semester off to work or transferring to a less expensive school.

About to graduate
Technically, you don’t have to start paying back your loans for six months after you get your diploma. But you have a one-time opportunity to lock in an especially low rate now.

The federal formula gives you an additional 0.6% break on your rate if you consolidate during your grace period. In other words, you can lock in a 2.875% rate if you consolidate after July 1 but before the six-month grace period expires. (Remember, consolidation loans are rounded up to the nearest one-eighth of a percentage point, so the 2.77% rates on your variable loans would become 2.875% in consolidation.)

These rates don’t include any breaks offered by lenders. Potentially, you could knock off another amount with lender incentives for on-time payments, getting your rate as low as 1.625% within a few years.

If you consolidate, you’re supposed to start making payments -- in other words, goodbye grace period. But you shouldn’t miss this opportunity to snag an extra-low rate. Consolidated loans are eligible for forbearance and deferment if you don’t have a job, return to school or have other certain problems that prevent your being able to pay the loan immediately.

If you want, you can wait until September to consolidate, but just make sure you give your lender two or three months to process your application to make sure you get the best rate.

Graduated, not yet consolidated
In the last few years, borrowers have benefited from procrastination. Those who put off consolidation enjoyed ever-lower payments as the adjustable rates on their loans continued to fall.

You can let inertia rule for a little while longer. If you don’t qualify for the new-graduate break, there’s little risk in waiting to consolidate until next May, after the 2005 rates have been announced. If the rates go up, as many expect, you just need to get your application in before July 1, 2005. In the unlikely event rates go down next year, you can continue to wait.

Or you can simply consolidate later this year. Many experts are pretty certain rates have hit the bottom and say you might as well seize the day by submitting your consolidation request right after the rates change July 1.

The bad news for the already-consolidated
Many borrowers locked in what seemed like great deals in 2000 -- only to see the prevailing rate drop by more than four percentage points since then.

“My daughter consolidated her $45,000 in debt just before (Federal Reserve Chairman Alan) Greenspan started lowering interest rates,” fumed Steve Lustig of Greenwood Village, Colo. “I’ve called, written and e-mailed my congressional delegation (asking them to change the one-consolidation rule) . . . to no avail.”

Lustig said his daughter could save over $9,000 if she could refinance her loans at current rates, but chances for change are slim.

As Michael O’Brien of explains, major lenders have billions of dollars of loans in their portfolios that were consolidated at higher rates. Changing those rules would cost them a fortune and, some say, could even require a federal bailout, since the lenders count those loans as rock-solid assets.

The only way you can consolidate again under current rules is if you have another loan to wrap into the package. Even in that case, you won’t be able to lower the rate on the loans you’ve already consolidated. Remember, the consolidated rate is based on a weighted average of the rates on the underlying loans.

Your best bet: pay your loans off as quickly as possible. An extra $100 a month could pay off that $20,000 loan in half the time and save you over $12,000 in interest.

Parents with PLUS loans
Those with Parent Loans for Undergraduate Students might want to consolidate as they go. Since PLUS loans require payments shortly after the money is disbursed, parents can consolidate as little as 60 days after getting a loan. (Although most borrowers use consolidation to combine several loans, you can consolidate with just one.)

You do run the risk, if rates drop again, of not being able to benefit on the loans you’ve already consolidated. But if rates rise as expected, you will lessen the risk of winding up with loans from all four (or five) undergraduate years accruing interest at a higher rate.

At the end, you can consolidate all the loans into one. You don’t get a further break on the rates, but you’ll be able to streamline your payments into one.




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