Program Gives Graduates Chance to Trim Rates on College Loans

Attention recent college graduates:

Suffering under a high debt burden? Having trouble meeting those loan payments? Think your loan rates are too high?

The government and some private lenders have got a deal for you.

Because of a quirk in the federal law authorizing government-guaranteed student loans, for the next five weeks it will be possible for many borrowers to consolidate their loans at substantially lower interest rates than they now carry. And both the Department of Education and some private lenders, such as Sallie Mae, are eager to win your business.

“It’s a great time for students to take a look” at loan consolidation, said Deputy Education Secretary Marshall Smith. “It’s a big holiday present for them.”

The current situation is the outgrowth of a bitter fight in the summer between the Clinton administration and private lenders over the formula for computing interest rates for students.

A formula built into the law in the early 1990s and scheduled to go into effect last July turned out, because of changes in the capital markets, to result in sharply lower rates for students. These new rates would be so low, private lenders argued, that it would be impossible for them to lend profitably.

The government now makes student loans directly as well as guaranteeing ones issued by private lenders, so it is now in competition with the private sector for business. However, when private lenders threatened to quit the business, the Education Department conceded that if that happened the government could not meet the entire demand.

The upshot was a compromise formula adopted by Congress that lowered rates somewhat, but not as much as originally called for.

That was for new loans.

The Education Department argued that the new formula should also apply to older loans, most of which carry higher interest rates, if borrowers consolidated them. Private lenders opposed that, however. That dispute brought another compromise, in which the new formula was allowed to apply to consolidations done by the Education Department between Oct. 1, 1998, and Jan. 31, 1999.

The new formula currently works out to a rate of 7.46%. It is a variable rate, based on rates the Treasury pays on short-term borrowing, and is reset annually.

Private lenders are permitted to match that if they wish, but are not required to.

After Jan. 31, the rate on loan consolidations will be the weighted average of the loans being consolidated (rounded to the nearest 1/8th of a percentage point), which generally will mean a higher rate than the one being offered now.

Some private firms such as Reston, Va.-based Sallie Mae and USA Group Inc. of Indianapolis, while not cutting rates directly on the loans they own, are offering discount programs that can result in as good or better deals.

Under their programs, borrowers can reduce their rate by 0.25 percentage point by agreeing to automatic electronic payment. And by making 48 consecutive on-time payments, they qualify for an additional 1 percentage point reduction. By using both benefits, a borrower could, for example, reduce an 8.25% loan to 7% after four years.

The actual annual percentage rate on these deals depends on the term of the loan, because an 8.25% loan would be at 8% for four years--the 0.25 percentage point reduction is available right away--then drop to 7% for the remaining term. The longer the term, the greater the APR reduction.

Thus, according to Sallie Mae’s calculations, the APR would work out to 7.62% on a 12-year, 8.25% loan if the borrower qualified for both rate reductions, whereas it would be 7.39% on a 30-year, 8.25% loan.

The maximum term allowed varies with the size of the loan. Very large loans can be stretched out to 30 years.

“Generally the people who need consolidation are the people who have fairly high balances,” said Elizabeth Belli of Sallie Mae, though those willing and able to pay faster can request a shorter term, and there are no prepayment penalties if a borrower is fortunate enough to be able to pay off early.

If you are a graduate who has borrowed under either the guaranteed or direct education loan programs--or a parent, since parental PLUS loans can qualify--and think you might benefit, you need to do two things:

* Get going now (applications have to be in by Jan. 31).

* Shop around.

Consolidation with the Education Department offers a number of benefits, notably the immediate interest rate reduction. Also, keeping the lower rate doesn’t depend on electronic funds transfers or a perfect payment record. Such features may be particularly important to the recent graduate who is struggling financially.

However, the department’s rate is variable, capped at 8.25%, so there’s a risk that a surge in interest rates would cause your payment to jump in future years.

Private lenders offer different benefits. The lower, fixed rate offered by Sallie Mae, USA Group and others offers predictability as well as greater savings for borrowers with big balances and longer terms. Sallie Mae figures that a borrower with a $60,000 balance would save more than $25,000 in interest over 30 years by using its discounts instead of the Education Department’s program.

But be cautious. Some lenders offer reductions for unconsolidated loans that may be better than what you could get by consolidating. “Borrowers may be better off by keeping their loans unconsolidated if they qualify for discounts,” said Robert Murray of USA Group, which offers a two-point reduction for certain loans for on-time payment.

And, he noted, some loans, such as those under the Perkins program, can have much lower interest rates, so that borrowers may do better to leave them unconsolidated.

In shopping around, start with the entity that owns your loans now. Then compare what’s offered by the government and by others, such as Sallie Mae and USA Group. Check also with your school’s financial aid office for suggestions.

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More Information

Let your fingers do some of the walking. Most players in the education loan market have Web sites, and some offer calculators so you can gauge the effect on your payment and interest costs of various alternatives. The Education Department can be reached at (800) 557-7392 or via its Web site at https://www.ed.gov; Sallie Mae’s number is (888) 2-SALLIE or (888) 272-5543 and its Web site is https://www.salliemae.com; USA Group’s number is (800) 448-3533 and its site is https://www.usagroup.com.