Time to Lock in Student Rates
College student loan rates are set to soar this July. But experts say borrowers who act within the next six weeks can save a bundle by converting their variable-rate loans into fixed-rate debt.
The reason: Most types of student loans have variable interest rates that are reset every July 1. Today’s variable rates are at historic lows, ranging from 2.77% to 4.17%. However, experts predict that those rates will jump by about 2 percentage points this summer.
Borrowers who consolidate their student loans before July 1 can lock in today’s historically low rates for the life of the new loan.
“You absolutely should do it,” said Mark Brenner, president of College Loan Corp. in San Diego. “There are no fees, no prepayment penalties, and you get to lock in the lowest rates in the 40-year history of the program.”
Why are student loan rates rising, and how can you avoid taking a hit? Here are some answers.
Question: What’s driving the rate hike for student loans?
Answers: Once a year, the Education Department adjusts student loan rates based on the yield set at the last 91-day Treasury-bill auction in May. This yield becomes the index rate for unconsolidated student loans. The Stafford loan rate is set by adding a margin of 2.3% to the index rate. The PLUS (Parents Loans for Students) loan rate is set by adding 3.1% to the index.
Interest rates on these loans are now 3.37% and 4.17%. (Those who started repaying their student loans before they had to are enjoying an even lower rate -- 2.77%.) Because yields on 91-day T-bills have risen 1.9% since this time last year and appear to be heading higher, experts anticipate that student loan rates will jump in July to more than 5% for Stafford loans and more than 6% for PLUS loans.
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Q: How much would that affect the cost of my loans?
A: That depends on the loan balance, how high rates go and how long you take to pay off the loan. However, an analysis by College Loan Corp. found that a student borrower with $20,500 in loans -- that was the average student debt converted to a fixed-rate loan last year -- would pay $2,100 to $2,700 more over a 10-year period if rates rose to 5.2%.
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Q: With interest rates on the rise, how can you avoid getting hit with a rate hike year after year?
A: Students can refinance all their student loans into one loan through a process called consolidation, in which the debt converts from a variable-rate loan that adjusts once annually into a fixed-rate debt.
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Q: Can you consolidate if you have only one loan, just to get the fixed rate?
A: Yes.
Q: How is the rate on a consolidation loan set?
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A: It’s based on the weighted average rate of all the loans being consolidated, rounded up to the next eighth of a percentage point. In other words, if the weighted average cost of the student’s debt is 2.77%, the consolidation loan’s rate would be 2.875%. If the average rate was 3.37%, the consolidation rate would round up to 3.375%.
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Q: Are there fees or charges to get the loan?
A: No. The only cost is in the rounding up of the interest rate.
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Q: Can I consolidate my loans when I’m still in school?
A: Yes. If you are in the Education Department’s Direct Loan program, you can convert your loan by contacting the department. The best place to start is the agency’s website at www.ed.gov. There you’ll find a questionnaire to determine whether you qualify and an application form.
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Q: What if I have a student loan from a bank?
A: That makes the process for current students a bit more complicated. First you ask to begin “early repayment” of the loan. (A loan does not qualify for consolidation unless repayment has begun.) Next you apply for a consolidation loan from the bank or another lender. Finally, you apply for an in-school payment deferral -- presuming that your aim is indeed to consolidate the loan and not actually to begin paying it off. That deferral lasts until you graduate or are in school less than half time.
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Q: That sounds tricky -- are you sure it’s legal?
A: Each step of the process is legal, lenders say. Lenders have asked the Education Department for guidance on whether it’s OK to put these steps together. The department is weighing whether to issue such guidance, but in the interim, private lenders -- which account for about 80% of the student loan market -- are going ahead.
Virtually all the major student lenders, including industry leader Sallie Mae, are gearing up to handle in-school consolidations. Some, such as Nelnet, even explain the multi-step process on their loan applications.
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Q: What’s the benefit to consolidating while I’m in school, if I don’t have to pay on the loan for years anyway?
A: With an unsubsidized consolidated loan, the interest that accumulates while you’re in school will accrue at a low fixed rate rather than a variable rate. And you’ll keep the low rate while you are paying off the loan after graduation.
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Q: What’s the downside of consolidating in school?
A: If the student has certain subsidized loans -- such as Perkins loans on which the government pays the interest while the student is in school -- an in-school consolidation is not a good idea because the student could lose that subsidy.
For those with unsubsidized loans, the only downside is that the borrower could lose the long repayment grace period after graduation. With variable-rate student debt, the borrower generally does not need to start repaying the loan until six months after graduation. With a consolidation loan, borrowers generally must begin repaying the debt within two months of losing the in-school deferment.
However, lenders say that if a borrower cannot start repaying shortly after graduation because he or she hasn’t yet found work, the borrower can apply for “forbearance,” which can delay the initial repayment date for as much as six months.
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Q: Any reason not to consolidate now?
A: “It’s hard to find an argument against it right now,” said Martha Holler, a spokeswoman for Sallie Mae.
In the past, the reason not to consolidate was this: Once a loan is consolidated, the rate can never be changed. If rates drop further, you can’t refinance to get a lower rate. But rates currently are at all-time lows and are poised to rise. So the chance of missing out on a lower rate is relatively slim, Holler said.
Or as Bob Murray, communications manager for loan guarantor USA Funds, put it, playing off a line from the movie “Casablanca”: “If you don’t consolidate, you’re going to regret it. Maybe not tomorrow, but soon -- and for the rest of your life.”
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Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” 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 previous columns, visit latimes.com/kristof.
