Take Advantage of Super-Low Student Loan Rates

The government is handing out graduation gifts: record-low interest rates on students loans.

On July 1, rates on Stafford loans fell to 3.42%, and rates on PLUS loans for parents dropped to 4.22%. These rates have fallen 4.77 percentage points over the past three years.

Maybe the rate change is not as exciting as, say, finding a job or winning the lottery. But rock-bottom rates mean lower monthly payments (good news if you're pinching pennies) and less interest paid over the life of the loan. In other words, financing a college education has become less expensive.

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If you have a Stafford loan from July 1998 or later, now you'll pay 3.42% interest instead of 4.06%. The lower rate translates to savings of about $62 per year on the average $17,000 federal loan debt for undergraduate borrowers. Those who've come out of grad school with the average $23,000 in federal loans will cut about $83 annually off their payments.

The savings might not seem like a lot. But if borrowers were paying the maximum 8.25% rate instead of the record-low 3.42% rate, they would pay almost $5,000 more in interest over the life of a $17,000 ten-year loan (about $6,600 more on a $23,000 loan).

Rates on pre-1998 loans will be a little higher but still less than 5%. If you're still in school or in the six-month grace period following graduation, you'll pay only 2.82% interest. And parents with PLUS loans saw interest rates drop to 4.22% from 4.86%. Perkins loans won't be affected because they have a 5% fixed rate.

To take advantage of this sweet deal, you don't have to do a thing -- rates drop automatically. Stafford and PLUS loan rates are adjusted each July 1 based on the rates of short-term Treasury bills auctioned at the end of May. For more on the basics of student loans, see our tutorial.

How to lock in low rates

If you want these great rates to last longer than a year, you'll have to refinance (or "consolidate," as lenders call it) your federal student loans before July 2004, when the rates change again. You can wait until June 2004 when the T-bill rates are announced to gauge if Stafford and PLUS loans will drop even lower. Once you consolidate, you can't do it again unless you're adding a new loan to the mix.

For those who consolidated a couple years ago and locked in at a higher rate, they might get some relief. There's a push in Congress to give borrowers who've consolidated another chance. Rep. Danny Davis (D.--Ill.) has introduced legislation to let borrowers refinance (again) at a variable rate rather than a fixed rate, and similar bills are in the works. Don't expect anything to come of these proposals until 2004, when Congress might address them as part of the reauthorization of the Higher Education Act, says Ivan Frishberg of Public Interest Research Group.

More than half the people with student loans don't know they have the option to consolidate, says Barry Morrow, chief executive of Collegiate Funding Services. Even though lenders call it consolidation, you don't have to have multiple loans. Because all you're doing is refinancing at a lower rate and setting a new repayment term (usually ten years), one loan is enough to take advantage of this deal. If you do consolidate two or more loans, the interest rate will be the weighted average of the loans combined (the bigger loan counts more), rounded up to the nearest one-eighth of a percent.

Morrow says most people who consolidate are recent graduates looking for immediate cash flow relief -- lower payments to put money back into their pockets or pay off credit card bills. Recent graduates can lock in the 3.46% rate if they consolidate before their grace period ends. (But wait until a month before the period ends because repayment starts immediately after you consolidate.)

When it's a bad deal

Consolidation isn't for everyone. Borrowers with just a few years left on their loans could end up paying more interest because the clock is reset on their repayment term. Those borrowers also may lose special discounts offered by their lenders. For example, Sallie Mae offers a one-percentage-point interest rate deduction if borrowers make 48 consecutive on-time payments. When you consolidate, you lose that deduction until you've made another 48 payments. And holders of some federal loans get special deferment options that they would lose if they consolidated. So check with your lender before consolidating.

You can't consolidate if you've refinanced your loans in the past, and you can't consolidate federal loans with private loans. Collegiate Funding Services has a program that allows borrowers to bundle their private and federal loans into one account with one monthly payment. But the federal and private loans are kept separate within the account. (Call 888-423-7562 for details.) And the federal government doesn't allow some loans, such as Law Access loans, to be consolidated.

The Education Department lists which loans can be consolidated, as well as who is eligible for a direct consolidation loan.

If you're eligible and interested in refinancing, first call your lender or check its Web site to find out what consolidation options it offers. Then you can shop around for a better deal if you have loans from more than one lender. You won't get lower rates because they're set by the government, but lenders such as Sallie Mae, Nellie Mae and Collegiate Funding Services offer discounts for timely payments that the federal government doesn't.