Students can lock in low rates by consolidating loans now

By Sandra Block
USA Today

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Student loan update Several developments could affect the cost of student loans: On July 1, new interest rates for federal student loans take effect. These may remain the same, but pay attention to the announcement. Consolidate your loans to lock in lower rates. Check into banks' "best rates" programs. Congress is weighing whether to make interest rates on consolidation loans fluctuate with market rates. Some consumer groups say that could increase borrowing costs.

On July 1, the federal government will announce the new interest rate for federal student loans, an annual event that causes sweaty palms and heart palpitations among college graduates with lots of debt. This year's graduates can breathe easy: Analysts expect the rate to remain near the current level of 3.42 percent.

Federal student loan rates are tied to interest rates for short-term Treasury bills set at the last auction in May. Unless T-bill rates rise significantly in the next four weeks, student loan rates will stay the same or fall slightly, says Mark Kantrowitz, founder of the Web site FinAid.

If T-bill rates don't change, the new rate will be 3.25 percent, says Patricia Scherschel, consolidation product executive for student loan firm Sallie Mae.

Rates for the Parent Loan for Undergraduate Students, or PLUS loans, are also expected to remain low, Scherschel says. If T-bill rates don't change, the new rate for PLUS loans will be 4.05 percent, down from the current 4.22 percent, she says.

The rate change is automatic, so if you have student loans and haven't consolidated them, your rate will automatically change to the new level on July 1. Remember, though, that the rates are adjusted annually. If the economy continues to improve, sub-4 percent interest rates will disappear in 2005.

When you consolidate loans, you lock in the weighted average of all your loans, up to the nearest one-eighth of 1 percent, and extend the payment period. If T-bill rates remain about the same during the next four weeks, many graduates will be able to lock in a rate of below 3.4 percent for up to 30 years.

Borrowers who consolidate during their grace period can lock in an even lower rate.

The grace period is a six-month window between graduation and the time you're required to start making payments. Interest accumulates during this period but at a lower rate.

Consolidating during your grace period enables you to lock in that lower rate for the life of your loan. If T-bill rates don't change, borrowers who consolidate during their grace periods will be able to lock in a rate of 2.75 percent.

Once you consolidate, you must start making payments. But many lenders will wait to process your application until the end of your grace period, allowing you to postpone making payments and still get the lowest possible rate.

Borrowers who are worried T-bill rates will rise between now and the end of May can hedge their bets. Many reputable lenders offer a "best rates" program. They'll accept your consolidation application now but wait to process it until the new rates are calculated. If the benchmark T-bill rate rises at the May auction, they'll consolidate before July 1, locking in current rates. If the rate falls, they'll wait until after July 1 to consolidate your loan.

Even if you decide to take your chances and wait until after July 1, don't wait too long to consolidate your loans. There's a move in Congress to make interest rates on consolidation loans fluctuate with market rates.

If the measure is adopted, future graduates, along with older grads who haven't gotten around to consolidating, will no longer be able to lock in a low fixed rate for the life of their loans.

The change is expected to be included in legislation to renew the Higher Education Act, which governs student loans and other student aid programs.

Supporters of variable rates contend that fixed-rate consolidation loans increase the cost of government subsidies when interest rates rise. That, they say, funnels money away from financial aid programs for low-income college students. A study commissioned by Sallie Mae estimates federal subsidies for consolidated loans will cost taxpayers $35 billion over the next seven years.

Consumer groups counter that the proposal would increase borrowing costs, making it even more difficult for students to afford college. Variable rates on consolidated loans would cost the average borrower with $20,000 in loans an additional $7,807 in interest over a 20-year period, according to the State Public Interest Research Groups' Higher Education Project.

When interest rates are high, variable rates could benefit borrowers. Graduates who consolidated their loans in 2000, for example, are stuck with a fixed rate of above 8 percent.

It's hard to imagine rates going much lower. If you're eligible to consolidate, don't put it off. Next year, you may not be so lucky.