Want to Consolidate Student Loans? Do Homework First

Interest rates on student loans are about to drop to the lowest levels in more than three decades, thanks to the recent rate cuts by the Federal Reserve.

That’s good news for the millions of Americans toting $180 billion in student loans--and it has lenders crowing that now is the time to lock in the low rates by “consolidating” student debt.

Student loan rates, which re-price July 1, will fall as much as 2.2 percentage points. Interest on student loans will range from 5.99% to 6.79%, depending on the type of loan and when the debt was incurred.

“That’s the lowest rate in the [35-year] history of the student loan program,” says Bob Murray, spokesman for USA Funds, an Indianapolis loan guarantor.

This low rate makes loan consolidation compelling, he adds. Why? Student loans usually have variable rates, meaning their interest rates rise or fall each summer depending on whether the 91-day Treasury bill rate was up or down during the final week of May. But when student loans are consolidated--that is, two or more loans are rolled into one--the new loan has a fixed interest rate.

In other words, by consolidating after July 1, you can lock in a historically low rate for the life of the loan.

But there’s no need to rush, says Patricia Scherschel, consolidation product executive at Sallie Mae, a student lender based in Reston, Va. Most borrowers lose nothing by waiting up to a year--right before the next rate change--before making a final decision. Either way, you get the benefit of the lower rates throughout the year.

In the meantime, students can investigate the various pros and cons of consolidating. That’s important because consolidations are irrevocable.

“This is a complicated product, and it’s a one-way deal,” Scherschel said. “I really want to caution people to look at all the aspects.”

What do you need to consider?

The basics

Consolidation loans do three things: They roll several loans into one monthly payment, they allow you to choose a new repayment schedule, and they turn a variable-rate debt into a fixed-rate debt. Also, they don’t involve fees.

Many of the rules are set by the federal government. So no matter which lender you choose, the rate on a student loan consolidation would be the same. The interest rate would be based on the weighted average rate of all the loans you’re consolidating, rounded up to the nearest eighth of a percentage point.

So if all your loans are priced at 5.99%, your consolidated loan would have a 6% rate. If the average rate on your loans is 6.38%, you’ll pay 6.5% on a consolidated loan. (The nearest eighth of a percentage point is 6.375, but the rule requires rounding up, not down.)

Once you lock in a rate through a loan consolidation, you can’t consolidate again to take advantage of an even lower rate. People who rushed to consolidate last June to avoid steep rate hikes that hit in July 2000, for example, are likely to have loan rates stuck above 7% today. These borrowers can’t refinance a second time.

Timing

Scherschel suggests that most students wait until June 2002 to make a final decision. If the May 2002 Treasury auction indicates that loan rates will go up at the July 1, 2002, re-pricing, you can consolidate your student loans then to lock in this year’s lower rates.

The only people who might want to consider consolidating sooner are recent graduates who are still in repayment grace periods, which typically end six months after graduation. If you consolidate while still in a grace period, the interest rate on your loan will be even lower--currently 5.5% rather than 6%. That too is a federal requirement.

However, once you consolidate, your grace period is over, and you must begin repaying the loan.

Another advantage

Consolidating a loan also can help cash-strapped borrowers spread out their payments.

The combination of lower rates and longer repayment periods can allow some borrowers to cut their monthly payments nearly in half, says Vicki Zacchetti, spokeswoman for Collegiate Funding Services in Fredericksburg, Va.

The amount of time you’re given to repay would hinge on your total outstanding student debt. If the total debt amounts to less than $7,500, you must repay the loan within 10 years. However, if your loan amount is higher, the government gives you the option of repaying over longer periods. Those who have $60,000 or more in student debt can take as long as 30 years to repay.

Though stretching out repayment would cause you to pay more in interest charges over the long run, it’s a wise move if it allows you to repay other, higher-cost debts--such as credit cards--more quickly, experts note.

Disadvantages

Some people who consolidate loans can lose valuable benefits.

For instance, many lenders, including Sallie Mae, provide interest rate discounts to borrowers who have made their first 48 monthly payments on time. But those discounts don’t apply to consolidated loans, Scherschel said.

Someone who qualified for this discount would see his or her 5.99% variable-rate loan drop to 3.99%--vastly better than the 6% rate this borrower would get from a consolidation loan.

Collegiate Funding says it will still provide discounts of up to 1 percentage point on consolidated loans, provided borrowers make the first 36 monthly payments on time. But Collegiate Funding is an exception.

Moreover, a discount commonly available to customers who make their student loan payments through automatic debits to their checking accounts is rarely offered on consolidated loans.

Certain types of loans--most notably subsidized Perkins loans--shouldn’t be consolidated if the graduate thinks he or she might go back to school. Why? The government’s in-school interest rate subsidy would be eliminated if the loan were consolidated, Scherschel says.

Also, married couples shouldn’t combine and consolidate their loans, Scherschel said. Usually, if you die or become totally and permanently disabled, the government will forgive your debt. But if you have combined your loans, the loan doesn’t get forgiven; the survivor is obligated to pay it.

In addition, you can normally delay repaying a loan if you have an economic hardship or go back to school. But in the case of a combined loan, both spouses might have to be out of work or back in school for the deferment to be approved.

Information on student loan consolidations is available from your lender. Also, the Department of Education ([800] 4-FED-AID) provides information about loan consolidation rules. And many lenders, such as Sallie Mae (https://www.salliemae.com), provide information and consolidation calculators on their Web sites.

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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns, visit The Times’ Web site at https://www.latimes.com/perfin.

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Paying It Back

Student loans generally must be repaid within 10 years of graduation. But if you consolidate your loans--and you owe at least $7,500--you can stretch repayment over longer periods.

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Loan amount Maximum repayment period* Less than $7,500 10 years $7,500 to $9,999 12 years $10,000 to $19,999 15 years $20,000 to $39,999 20 years $40,000 to $59,999 25 years $60,000 or more 30 years

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* Maximum repayment periods exclude extensions granted for financial hardship.

Source: USA Funds