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Taking care of your debts

By Gerri Willis, CNN/Money contributing columnist

NEW YORK (CNN/Money) - It's the end of the school year. The good news? It's the end of the school year. The bad news? It's time for college graduates to begin paying back student loans.

But there is a plus for millions of borrowers and recent graduates. Starting July 1, interest rates on federal student loans will drop to historic lows. Plus, this will be even more beneficial for graduates looking to consolidate their loans.

What do students need to know before they put a new lease on their student loan life? Here are today's five tips.

1. Get the lowdown on loan rates.
Student loans make up the largest part of financial aid -- 54 percent of the total financial aid awarded each year.

Now, beginning on July 1, federal student loan rates for 2004-2005 will fall to their lowest level in the 39-year history of federally guaranteed student loan rates, bucking other recent interest rate trends. These new rates could mean substantial savings for college students and graduates trying to pay off a mountain of student debt.

Let's break it down. Interest rates on Stafford loans, which are the bread and butter of student loans, will drop to 3.37 percent from 3.42 percent in 2003-2004 and the rates on PLUS loans will fall to 4.17 percent from 4.22 percent. PLUS loans are federally sponsored loans geared towards parents.

These interest rates are calculated by the Department of Education and are tied to rates for short-term or three-month Treasury bills set at the latest auction, held last month. Student loan rates are reset every year on July 1, based on the auction held the last week in May.

For students still in school and their families, rates will be automatically applied to the new student loans they take out in the academic year ahead. However, upcoming grads must act soon to benefit by consolidating their loans and locking in the new rates for the life of the loan.

The College Loan Corporation says this is especially important for the class of 2004. During the six months after graduation, loan holders will be given a "grace period" that applies to students. This is a window of opportunity during which they can lock in an even lower rate.

Starting July 1, the rate for consolidating federal student loans during the grace period will be 2.875 percent. For those who wait until after the grace period to consolidate or for parents with PLUS loans, the rate will be in the neighborhood of 3.375 percent.

Just how much can you save? Let's take a look at an example. Consider a $40,000 Stafford loan to be repaid over a 10-year period. Also assume that the rate has risen to 5.72 percent, a five-year historical average. Repaying at 5.72 percent over 10 years will result in interest of $12,617.

However, if you consolidated your loan after the six-month grace period at 3.375 percent over the same amount of time, interest would be $7,185 and if you consolidate at the 2.875 percent during the grace period, the interest drops even more to $6,073.

2. The ins and outs of consolidation.
What exactly does it mean to consolidate? It is the process in which graduates can combine all of their student loans into one.

Keep in mind, you cannot consolidate your student loans if you are still in college, unless you are enrolled as a part-time student. When one consolidates, the student debt changes from a variable-rate loan that adjusts once a year into a fixed-rate loan. Only consolidation loans are fixed and the fixed rate can never exceed 8.25 percent.

By consolidating you are lowering your monthly loan payments -- however, you are extending your term beyond the 10-year repayment plan that is standard with federal loans. The downside is that you could end up shelling out more money in interest payments because you will be making loan payments over a greater period of time.

So, is consolidation right for you? Well, if you believe that interest rates will not remain at record lows, you may want to lock in the rate now. It also depends on what your financial situation is and what your goals are. If your goal is upfront financial liquidity or more money in your pocket for the short-term, then consolidating may be the way to go.

According to Brian O'Connell, author of "Student Loan Debt -- Get Out from Under Once and for All," if your goal is to pay off your student debt ASAP and you are financially able to afford the monthly payments, then it's not such a great idea.

There are several other pros and cons of consolidation. On the plus side, besides the fixed interest rate, there is immediate debt relief since your monthly loan payments will immediately decrease.

You will also have an easier payment plan, as you will only have one monthly loan payment as opposed to several. You also have the option of paying off your loan early with no penalty.

Incentives are also key. For example, College Loan offers a one percent cash rebate on outstanding balances for borrowers who make their first six monthly payments on-time. It also offers a 0.25 percent interest rate reduction for enrolling in automatic payments.

Collegiate Funding Services and Sallie Mae also offer the 0.25 percent interest rate reduction for automatic payments. And Sallie Mae gives an additional one percent reduction to people who make regular, on-time payments for three years on loan balances of more than $10,000. Be sure to shop around.

Finally, interest on consolidated student loan plans is tax deductible. Student loan borrowers can deduct up to $2,500 in interest payments annually as long as their annual gross income is less than $50,000 (and below $100,000 for married couples).

Among the cons of consolidating is that current law allows a borrower to consolidate only once, so if interest rates go down even further, you're stuck with the fixed rate on your loan. There is no grace period for a consolidated loan. Once you combine, you must begin payments right away. And, as we mentioned earlier, extending the repayment of the loan may increase the total interest paid over the lifetime of it.

Graduates have the option of extending repayments depending on the total amount of their loans. Graduates with $7,500 can extend up to 12 years; $10,000: 15 years; $20,000 up to 20 years; $40,000: 25 years and $60,000 or more, up to 30 years. But be aware that for many it makes no sense to pay off $10,000 over a 15 year time frame considering the interest you'll accrue.

3. Know your consolidating rights.
Applying for a consolidated loan is inexpensive and easy. In fact, several lenders are recommending borrowers apply right online. If you feel more comfortable speaking to an individual, pick up the phone and call the lender to get an application.

Potential student loan savings
$40,000 Stafford loan over 10 years

Interest Paid
Repay at 5.72% * $12,617
Repay at 3.375% consolidation loan $7,185
Repay at 2.875% consolidation loan $6,073

* assumes 5 year historical average
Source: College Loan Corporation

The information needed to complete the application includes name, social security number, school information, references and the loans being consolidated. O'Connell says to be careful not to allow your lending institution to get away with rejecting your loan request. By law they can't reject you for the amount of loans you wish to consolidate, the school you attended, or the types of repayment schedules.

Also note that these loans do not require a credit check, any cosigners, costs or fees when you apply, employment check or any other qualifying criteria except for your student status.

One rule borrowers should be aware of is the single holder rule. This is a law that prevents borrowers who hold all their loans with one lender from consolidating their loans with another. But if you have loans with more than one lender or your lender doesn't offer consolidation, you can consolidate with any lender.

Also, while you can consolidate different types of federally guaranteed student loans into one, you cannot consolidate other types of student debt. For example, credit cards can't be combined.

Another thing to note is that a married couple can jointly consolidate their loans. While this may qualify the couple for a longer repayment schedule, it can also cause problems if the couple gets divorced down the line. If one ex-spouse fails to make a monthly payment, the other spouse is responsible and his or her credit report could be affected.

If you feel you can pay a bit more each month, go ahead. College Loan suggests paying your expected payment each month, plus an additional one and see if you are comfortable with that.

Finally, if you are still not sure whether or not to consolidate, consider your time frame. If you are already six to eight years into a 10-year repayment schedule, it may be easier for you to simply continue to pay it off than extend the loan.

For more information log onto or call 1-800-2-COLLEGE. Sallie Mae offers information on consolidating at or by calling 1-800-448-3533.

4. Young blood beware.
A recent survey found that only 10 percent of this year's graduating class has secured a job. For that reason, it will most likely be difficult for graduates to begin paying off student loan debt immediately. And even if he or she finds a job right out of school, chances are it's not paying a huge salary.

If this is your situation, you may want to proceed with a bit more caution when considering consolidating. First things first. Make sure to call your lender and let them know your situation.

Let them know you would like to use as much of your grace period as possible. In fact, some lenders will allow you to apply for consolidation during the grace period and you have the option of asking them to hold off on the actual process until after the six months in order to help you get on your feet financially. But interest may accrue during that time, depending on what kinds of loans you have.

In general, you'll want to keep in mind that the applications could take some time to process, so you probably don't want to wait any longer than four months in the grace period before you apply. says students who are having trouble making their payments should consider some of the alternate repayment terms for federal loans.

For example, income-contingent payments are adjusted to compensate for a lower monthly income. Graduated repayment starts the payments at a low level (usually interest only) and gradually increases the payments until the balance is paid off. And extended repayment allows you to extend the term without consolidation.

It also can't hurt to simply ask your lender for a lower rate. If you still have questions, upcoming grads may also want to speak to their school's financial aid officer. The officer should be able to help lead you in the right direction as far as your loans are concerned.

Also keep an eye on the mailbox. Some lenders will send out information to upcoming graduates about repayment schedules.

Finally, make sure to be careful of marketing pitches. Freshly-minted graduates are a favorite target of marketers for everything from credit cards to cell phones. Lenders will sometimes offer these services along with student loan information. But the last thing you want to do is load up on more debt.

5. Don't consolidate the forgiven.
Certain disabilities and jobs such as military service or volunteer work may qualify you for having your student loans forgiven. But if you consolidate the loans, chances are you will forfeit the opportunity.

Experts also advise against consolidating Perkins loans. These are federally subsidized loans for needy students that offer special benefits that are lost in consolidation. Log onto or for a list of professions or circumstances that qualify.






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