Student Loan Consolidation: The Other ReFi Boom

You've heard about refinancing in the mortgage market. Who hasn't? Interest rates are at all-time lows. Folks have refinanced two and three times in as many years to save thousands of dollars in interest they would have otherwise paid.

There's a similar lesser-known boom happening in the world of federal student loans, because refinancing or consolidating them can also help borrowers save thousands of dollars in interest expense.

The two most common types of federal student loans available today are Stafford loans (for students) and PLUS (Parent Loans for Undergraduate Students). The variable interest rates on these loans are the lowest they have been in over 30 years - currently, Stafford loans carry a variable rate of 3.46% while the student is in school, deferment and grace, and 4.06% in repayment. PLUS loan interest rates are currently 4.86% regardless of the student's status. If those rates would hold over the standard 10-year repayment term, that would be the end of this story. But, they won't hold. Federal student loan interest rates reset every year on July 1; Stafford loans rates can climb as high as 8.25% and the PLUS cap is 9%.

The great news for borrowers is that consolidating these loans locks in a low interest rate. The formula for determining a Federal Consolidation Loan interest rate is to take the weighted average of the interest rates of the loans the borrower wishes to consolidate and round it up to the nearest 1/8%. So, for example, if a borrower had only Stafford loans in repayment issued since July 1, 1998, the variable interest rate on these loans is currently 4.06%, and the fixed interest rate for that borrower's consolidation loan would be 4.125%. That's 4.125% for the life of the loan - which can be up to 30 years depending on the borrower's level of indebtedness.

Now, that's a deal every person with student loans should be considering right now. Because on July 1, 2003 rates will reset.

And there are other advantages to federal student loan consolidation. With extended repayment and graduated repayment options, borrowers' monthly payments can be reduced by 50% or more - especially helpful to recent graduates trying to make ends meet. And, if a borrower has multiple lenders and multiple monthly payments, consolidation lets the borrower make a single and (generally) a lower payment to a single lender - simplifying bill payment and improving cash flow. Finally, federal student loan consolidation is free - there are absolutely no fees to consolidate.

Although the terms of a Federal Consolidation Loan are exactly the same, regardless of who lends you the money, a number of lenders are offering incentives to get borrowers to consolidate with them. And, these incentives can save borrower hundreds, even thousands of dollars in additional interest. Most common is a .25% interest rate discount when borrowers agree to repay their new consolidation loans electronically (direct debit). A more significant discount is offered by some lenders when borrowers make timely monthly payments on their new consolidation loans. For example, ConsolidateYourLoans.com offers a 1% interest rate reduction after the borrower has made the first 36 consolidation loan payments on time. Other lenders offer the same discount after 48 or 60 payments, and others offer lesser discounts at other payment intervals, but the idea is the same. Just keep in mind, the faster you get the discount and larger the discount is, the more you can save.

There are a handful of federal student loan consolidators and, right now, the volume of loans they are originating is large, but manageable. Most consolidations are completed in 45-60 days. But, you can bet that the number of people seeking consolidation is going to grow as the deadline (June 30, 2003) approaches, and lenders will see an unprecedented number of requests that will most certainly bog the system down to some extent. So, if loan consolidation sounds like a good idea to you, read on to see if it warrants your further investigation and, if it does, get your application in quickly.

Is Student Loan Consolidation Right for You?

Federal student loan consolidation is a great financial opportunity, but it's not right for everyone. To make the best choice for you, you should consider the following:
Q. Can you take on a longer repayment term in exchange for lower monthly payments?
A. For most borrowers, loan consolidation extends the repayment term from the standard 10-year (Stafford loan) term to up to 30 years, depending on your balance. A longer repayment term means that, unless you prepay your loan, you will pay more interest than you would on your unconsolidated loans. You can control your interest cost by choosing one or more of the following:
·Request a shorter repayment term than your balance allows.
·Loan consolidation programs offer a number of repayment options. If you can afford it, choose an equal payment plan. You should always make monthly payments that are as large as you can comfortably afford, and an equal payment plan will cost you the least because you are paying all principal and interest due each month. A graduated repayment plan will reduce your monthly payments in the early years, and you might need to choose one of these plans to make ends meet, but they will cost you more in total interest.
·Prepay your loan whenever you can. Just send a note in to your loan servicer with your over-payment asking that it be posted to your principal balance.
·Don't get behind in your payments. Interest will continue to accrue on your unpaid balance, costing you more.

Q. Do you owe enough and have enough time remaining in your repayment term to really make a difference?
A. In today's rate environment, regardless of indebtedness, most people who have graduated recently or have been repaying their loans for less than 5 years will benefit. To get a rough estimate of your savings with a consolidation loan, go to www.ConsolidateYourLoans.com, click on "Calculate My New Loan", complete the simple worksheet and click "Consolidate".

About the Author

Elizabeth Belli is National Director of Marketing for Student Trust Inc. in Rockville, MD. Prior to that, she spent 10 years with Sallie Mae, the largest student loan company in the U.S.