Locking In a Low Student Loan Rate
Interest rates on student loans will fall to an all-time low next month, presenting indebted college graduates with an opportunity to lock in a low rate for the life of their loans.
The change will save the average student borrower hundreds--possibly even thousands--of dollars, experts said. Those who are heavily indebted, such as Brooke Gurland-Garrow of Brooklyn, N.Y., who ran up $100,000 in student loans while working her way through medical school, will save considerably more.
“The interest rates when I was in medical school [in the late 1990s] were 8% to 10%,” Gurland-Garrow said. “I remember thinking that this was killing me. But what are you going to do? I had to borrow. I’m really fortunate rates have dropped so much.”
Cuts Are Extra Help
for Recent Graduates
When student loan interest rates are adjusted July 1--as they are every year--they’ll fall nearly 2 percentage points to the lowest levels in history. Depending on the type of loan and when it was made, rates will range from 3.46% to 4.86%.
The rate cut couldn’t come at a better time for college graduates, who are facing a tight job market at the same time that average loan balances have soared, said Ellynne Bannon, director of the CalPIRG higher education project. About 64% of all students borrow to finance college today, Bannon said, and their average loan balance has nearly doubled to $16,928 over the last eight years.
The fact that student loan rates are headed for all-time lows--and probably won’t fall much further--presents borrowers with a potentially lucrative decision. Although student loan rates are variable and can rise or fall each year, borrowers can lock in a fixed rate by consolidating their loans, Bannon said.
There are no fees involved, but the interest rate on a consolidation loan can be one-eighth of a percentage point higher than on a variable-rate loan. Also, unlike mortgages, which can be refinanced as many times as a homeowner wants, student loans can be consolidated just once. So if interest rates drop after a borrower consolidates, he or she misses out on the lower rate.
As a result, most borrowers would be wise to wait until next spring before deciding whether to consolidate their student loans to lock in this year’s rate. Here’s why:
The annual adjustment of student loan rates is based on the three-month Treasury bill rate set at the Treasury’s final auction each May. If interest rates fall over the next 12 months, borrowers will be able to tell by the results of the May 2003 auction whether the student loan rate will be adjusted higher or lower the following July 1.
If the rate is expected to rise, borrowers still would have time to consolidate their loans, locking in this year’s low rate. If it’s poised to drop, they can wait for their variable-rate loans to be adjusted lower.
There’s one exception. Recent graduates whose loans still are in the deferment period--the six months after graduation when payments on student loans are deferred--may want to consolidate right after the July adjustment. The reason: If you consolidate while in deferment, your rate is 0.6 percentage point lower than it would be after the grace period. That would make the rate on a recently secured Stafford loan--the most common type of student loan--just 3.46%, said Maureen McCarthy Mellow, an education funding expert with Academic Management Services in Swansea, Mass.
Consolidating Typically
Ends Grace Period
On the other hand, consolidating generally ends the deferment period (unless the borrower consolidates through the government’s direct-loan program), so the borrower usually needs to start paying back the loan right away. That said, for someone who has a job, the rate break can make the accelerated repayment worthwhile.
Generally, all that’s required to qualify for a consolidation loan is that the student (or parent, if that’s who is repaying the loan) has student loan debt that is not in default. Some lenders also require that you have a minimum amount of debt, such as $7,500 or $10,000.
To consolidate, the borrower must first go to his or her lenders to inquire about consolidation. If there are several lenders, the borrower can choose whichever lender offers the most advantageous terms or best service. (Terms don’t vary dramatically from lender to lender. But some offer more repayment options than others. Some give interest rate breaks to graduates who are willing to repay with automatic debit plans, or offer attractive services such as calculators on their Web sites and toll-free phone counseling.)
Borrowers are generally offered four repayment plans on a consolidated loan:
* Standard repayment, which requires the balance be paid in full within 10 years.
* Extended repayment, which stretches fixed payments over 12 to 30 years.
* Graduated repayment, similar to extended repayment, except the payment amount gradually increases.
* Income-contingent repayment, which bases monthly payments on what the borrower can afford.
Stretching the payments beyond the standard 10 years means a borrower will pay more in total interest, cautioned Mo Barakat, senior financial advisor with American Express in Los Angeles.
But if that allows a borrower to contribute more to a 401(k) plan or to save for a near-term goal such as buying a house, that’s a reasonable trade-off, he said.
“For those who have a cash-flow crunch, [stretching out payments with a] consolidation makes sense because then they can get on with the other goals in their life, like saving for a home or a wedding,” he said. “To expect young people to postpone other goals for a decade or more while they pay off their student loans is just too much.”
Moreover, student loans have no prepayment penalties, so it can make sense to stretch out the repayment over the longest period possible and pay off the balance early, if possible.
Most lenders have loan counselors who can walk graduates through the consolidation process, McCarthy Mellow said.
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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 www .latimes.com/perfin.
