Save a Bundle on Your Student Loans
Act soon to net a low, locked-in interest rate on all that debt.
By Jane Bennett Clark, Senior Associate Editor
From Kiplinger's Personal Finance magazine, June 2004
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Quick quiz for college grads: Jack and Jill each took out $15,000 in student loans. A year after graduation, Jack is paying $152 a month on his debt, and Jill is paying $107. What does Jill know that Jack doesn't?
Answer: how to save money by consolidating. Refinancing your federal student loans fixes the interest rate at a point so low it's practically at sea level. Do the deed during the six-month grace period between graduation and when your first loan payment comes due, and you earn an extra discount of 0.6 of a percentage point. Besides keeping your interest rate low, you also have the option of extending the repayment period to free up even more cash for little details such as rent. And you get the convenience of making one payment a month instead of several.
As interest rates have fallen, graduates (and dropouts) have refinanced billions of dollars in federal student loans -- $31 billion in 2002 alone, up from $12 billion in 2000. Yet more than half of recent grads still don't know that they can consolidate, according to a study by Collegiate Funding Services, a major student lender.
Kate Bienen is one of the smart ones. Bienen, who graduated from Northwestern University last June, wasted no time in taking advantage of the current loan-consolidation rate of 3.42%. She refinanced four Stafford loans through Citibank last fall, which also qualified her for the grace-period discount. She got an additional break of 0.25 of a point because her monthly payments are electronically deducted from her bank account. Her new, fixed rate of 2.57% saves her $30 a month -- which she's using to prepay the outstanding principal on her loan.
Rates on Stafford loans -- the most common type of student loan -- are adjusted annually on July 1. The new rate -- based on the 91-day Treasury bill, plus 1.7 percentage points during the six-month grace period and 2.3 percentage points afterward -- is posted in June, so you can scope out both existing and new rates and lock in the better deal. If you apply in June, some lenders will delay processing your paperwork until July if the rate is about to drop, as is possible this year.
Calculations get a bit more complicated when you're consolidating several kinds of loans, such as Stafford and Perkins loans (Perkins loans are doled out by individual schools), or Stafford loans taken out before and after 1998, when the loan structure changed. In these cases, the rate is based on the weighted average of interest rates on all the loans, rounded up to the nearest one-eighth of a percentage point and capped at 8.25%. Lenders will do the math for you.
Who qualifies? You don't need a credit check or collateral to consolidate. Anyone who is out of school or attending classes less than half time can qualify (students holding direct federal loans may be able to consolidate while still in school). Some lenders require that you combine at least two loans -- they won't refinance a single loan -- or carry a minimum loan amount, say, $10,000.
Think twice about consolidating Perkins loans, especially if you plan to continue your education. The government subsidizes interest on a Perkins loan while you're in school, and it may forgive the loan entirely if you pursue certain professions, such as law enforcement. Those benefits don't transfer to the new loan. Similarly, grads who are far enough along in repayment to earn a prompt-payment discount -- usually 1% -- could lose that reward.
If you've consolidated once, you can't do it again unless you have at least one federal student loan outside that debt. There is, however, a way around the restriction. If you plan to borrow for graduate school, you can consolidate your undergraduate loans during their grace period and defer payment on the combined loan once you return to graduate school. That still leaves you the option of consolidating any grad-school loans down the road.
To make sure you get the grace-period rate, give the lender enough time -- six to eight weeks -- to get your paperwork from the original lenders. And make sure the lender delays signing off on the new loan until the end of the grace period; otherwise, you'll have to start repaying right away.
Get the ball rolling. Congress never intended for the consolidation program to turn into a vehicle for refinancing variable-rate student loans at a low fixed rate, even though that's what has happened as a result of the precipitous drop in interest rates in recent years. Some lawmakers argue that the existing setup subsidizes graduates who are already in the work force at the expense of current students, and they'd like to change the system so that consolidated loans carry variable rates. Congress isn't likely to do anything before November.
If only one institution holds your loans, you must give that company first dibs on combining your debt. If the lender declines, you can shop around. Call the number on your statement and ask for an application, or print one from the lender's Web site. If you don't know who holds your loans, check the National Student Loan Data System (800-433-3243).
Grads beholden to several institutions can shop among all lenders, chief of which are Sallie Mae (800-448-3533), Access Group (888-250-6401) and Collegiate Funding Services (800-423-7562). Look for special breaks, which are sometimes offered if you pay on time or electronically. For instance, Collegiate Funding Services promises to knock one percentage point off your interest rate if you make 36 consecutive payments promptly; some lenders demand 48 on-time payments before giving a discount.
Other ways to save. If you're truly strapped for cash, you could extend your repayment period as well as reducing your interest rate. That lets you cut your monthly tab by as much as half, although you'll end up paying more in interest over the life of the loan.
Say you're consolidating $17,000 in Stafford loans at 2.82%. You could stretch repayment to 15 years from the standard ten and reduce your monthly bill to $130 from $182. Your total interest cost will go up by about $1,500, but that may be the price you pay to have the wherewithal to live on your own instead of with Mom and Dad.
Struggling artists who expect to hit it big a few years hence may select a graduated repayment plan, which starts off with interest-only payments. A variation is the income-sensitive plan, which pegs monthly payments to your income and total debt.
--Reporter: Elizabeth Kountze