‘Refinancing’ Student Loans
Student loan rates will hit a new low in July, which has some lenders crowing that now is the time for both graduates and indebted parents to consider consolidating outstanding loans to lock in the new rates.
“Just about every borrower who isn’t in their last year of repayment should probably take a look at consolidating their loans,” said Bob Murray, spokesman for USA Funds, an Indianapolis-based student loan guarantor.
Loan consolidation is the student loan industry’s version of mortgage refinancing. It allows borrowers to put all their student loans in one package. In the process, they can stretch out the repayment period and take advantage of low interest rates by converting variable-rate debt into fixed-rate debt.
Stafford loans -- the most common type of student debt -- offer variable rates that are reset once annually on July 1, based on the 91-day Treasury bill rate set at the federal government’s final auction in May. As a result of that auction, which was held Wednesday, student loan rates will hit new lows this July.
Specifically, the rate on most loans already in repayment will fall to 3.42% from 4.06%. Rates on loans that are in a grace period that lasts six months after graduation will be even lower -- 2.82%, said Clark McGhee, executive vice president of Collegiate Funding Services in Fredericksburg, Va.
The rate on loans taken out by parents to pay their kids’ education expenses -- called Plus loans -- will be slightly higher, set at 4.22%, based on the latest Treasury auction. Some older student loans -- those made before 1998 -- also will bear higher interest rates ranging from 3.62% to 4.22%, Murray said.
Still, the new rates will be the lowest in the history of the guaranteed student loan program, said Cary Katz, chief executive of College Loan Corp. in San Diego. “No one can predict interest rates, but I can’t imagine the rates going much lower than this.”
The question of whether interest rates have reached bottom is an important one for any borrower considering consolidation. Consolidated loans can’t be continually “refinanced” like a mortgage. Once a loan has been consolidated, the rate is set and cannot be reduced within the guaranteed student loan program.
That’s a lesson many borrowers have learned the hard way, noted Laura Tarbox, a Newport Beach-based financial planner. One of Tarbox’s clients consolidated his loans in 1996, when interest rates dropped to 7.75%.
“The rate looked good at the time, but it sure doesn’t now,” Tarbox said.
Other cautions about consolidating:
* There are no fees charged to consolidate a loan, but the loan rate is the weighted average of all loans you consolidate, rounded up to the next one-eighth of a percentage point. In other words, the rate on unconsolidated loans is slightly better than that on consolidated loans.
On the other hand, most unconsolidated student loans must be paid off within 10 years. Borrowers who consolidate loans in excess of $7,500 can stretch their payments over a longer period. The time frame varies based on the loan amount, however. The bigger the loan balance, the more time borrowers can take to pay. (See chart)
* Stretching repayment over an extended period reduces monthly payments but causes the borrower to pay more in interest charges over time. Still, many financial planners say locking in a 3% rate for a 30-year stretch isn’t a bad idea, especially since there are no prepayment penalties on student loans. If borrowers want to pay faster than their loans require, they can.
* Those who consolidate while their loans are in a grace period may lose the ability to go payment-free for the six months after college graduation, which can be a big loss in today’s lackluster economy. Although it’s a good idea to consolidate while still in the grace period because it allows the borrower to lock in a lower rate, borrowers should apply for consolidation near the end of the grace period to take advantage of the payment-free benefit, said Patricia Scherschel, consolidation product executive at student lending giant Sallie Mae in Fishers, Ind.
* It may not make sense to consolidate Perkins loans, which are federally subsidized fixed-rate loans, if the student is likely to go back to school or defer repayment, Scherschel said. That’s because the government pays the interest on Perkins loans when they’re deferred. Once a Perkins loan is consolidated, that subsidy is lost.
* Although the government sets rules for the student loan program, including setting the maximum rates for the loans, lenders have the right to cut the interest rates if they so choose.
Lenders commonly provide discounts for on-time payment and for those paying their loans with automatic debits. But the size of the discounts and how they work varies from lender to lender. Some, such as All Student Loan Corp. in Los Angeles, provide the on-time payment discounts immediately, for instance. Others, such as Sallie Mae, require the borrower to make a set number of payments on time before the discounts are applied.
In either case, however, the discounts are eliminated if the borrower pays late. There are no second chances, said Chris Chapman, All Student Loan’s president and chief executive.
* Shop around if you can. Borrowers who have just one lender must go to that lender to get a consolidation loan, unless that lender doesn’t provide these loans. But those who have more than one lender can shop for a consolidation loan anywhere -- and there are loads of lenders competing for this business.
Be sure to ask about interest rates, borrower incentives and discounts. The incentives and discounts can save heavily indebted borrowers thousands of dollars in interest over time, Scherschel noted.
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Payback time
Student debt repayments can be stretched out for varying periods, depending on the amount of the loan. The bigger the balance, the longer students and parents can take to repay consolidated loans.
*--* Maximum repayment Amount of loan period* (years) Less than $7,500 10 $7,501 - $9,999 12 $10,000 - $19,999 15 $20,000 - $39,999** 20 $40,000 - $59,999 25 $60,000 or more 30
*--*
* Excludes authorized periods of deferment and forbearance.
** New borrowers on or after Oct. 7, 1998, with an outstanding balance of more than $30,000 but less than $40,000, may choose an extended repayment schedule of up to 25 years.
Source: USA Funds
Times staff writer Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com.
