Payback Time
Attention, students, grads, and parents: Act now to lock in low rates on your college loans
John Kingman, a commercial banker from Henderson, Nev., is a financially savvy guy. So he was a little skeptical when a recent letter urged him to act fast to lock in what sounded like too-good-to-be-true interest rates--2.6 to 4 percent--on his and his son's federal education loans. But the offer was legit. Kingman filed his application to grab the low rate on the loans he'd taken out to help pay his youngest son's college expenses. And Kingman made sure his son, who just graduated from Arizona State University, did the same for his student loans, before he even cleaned out his apartment or found a job. "This is going to save us a substantial amount of money," says Kingman.
Normally, when somebody touts a suspiciously good deal and pressures you to hurry, it is wise to run the other way. But parents, college students, and recent graduates really are being handed the bargain of a lifetime on federal education loans. But the deal expires June 30.
Every July 1, the federal government sets interest rates for student and parent education loans. It does so by adding a premium (from 1.7 to 2.5 percentage points, depending on the loan) to the rate of the last 91-day treasury bill auction in May. Last year, T-bills went for 1.07 percent. So far this May, they've been selling for about 2.9 percent. So college loan rates are expected to jump from their 40-year low by about 2 percentage points. That puts pressure not only on millions of procrastinating parents and graduates but also on millions of current students who last week got the go-ahead from the Department of Education to "consolidate" their student loans to nab the low rates. A consolidation loan replaces all of a borrower's old variable-rate federal education debts with one fixed-rate loan. (Private education loans are not eligible.) "This really is a now-or-never situation," says Kate Rube, higher education advocate with the State Public Interest Research Groups.
Before last week's ruling, the Education Department had estimated that 1.6 million Americans would consolidate this year, triple the number of five years ago when interest rates were higher. But lenders are now urging just about every student, graduate, and parent to give them a call. April applications at the Missouri Higher Education Loan Authority, a nonprofit lender in Chesterfield, Mo., were up 40 percent over last year. Now that current students are eligible, "May and June are just going to be crazy," predicts Greg Diamond, manager of consolidation and parental loan services.
Steals and deals. No wonder. Nearly two thirds of approximately 15 million undergraduates have federal student debt; the average debt to Uncle Sam upon graduation is $19,400. In addition, 40 percent of last year's 2.4 million graduate students borrowed an average $15,500 from the federal government. And there are 2.3 million recent graduates and parents who have enough federal debt to make consolidation worthwhile. One of the biggest groups eligible: the 735,000 parents like Kingman who borrowed an average of nearly $9,000 through the Parent Loan for Undergraduate Students (PLUS) program in the past school year.
The best deal is reserved for those who started borrowing after 1998. Students still in school or who have recently graduated can nail the rock-bottom rate of 2.875. Those who have been out of school for at least six months will be offered loans at 3.5 percent, while parents can lock in 4.25 percent. Most lenders will knock a quarter point off if borrowers pay by automatic debit. (For people with older loans, the government averages the interest rates on all the outstanding debt and then rounds up to the nearest one-eighth.) The rates are indeed a steal, considering that fixed-rate 30-year mortgages charge at least 5.2 percent these days. On top of that, up to $2,500 in education loan interest is tax deductible for individuals who earn less than $65,000 and couples with incomes under $130,000.
A new analysis prepared by the College Loan Corp., a San Diego-based lender, shows the power of the low rates. A recent graduate with $20,000 in Stafford loans (the biggest federal student lending program) would pay $190 a month and a total of $2,761 in interest over 10 years. If the same borrower waited until July 1 to consolidate, next year's interest rate--estimated to be between 4.5 and 6 percent--would kick in. The borrower would pay about $214 a month and $5,600 in interest over 10 years.
Like every good deal, this one has some eye-crossing fine print. Borrowers who have already consolidated at higher interest rates are out of luck, unless they have at least one unconsolidated federal loan. Most lenders won't bother with those who owe less than $7,500. Any student or graduate who plans, say, a public-service career that offers loan forgiveness shouldn't consolidate, since most of those programs pay off only the original federal loans. Financially needy students who qualified for low-interest federal Perkins or subsidized Stafford loans may also want to sit pat to preserve other generous benefits such as interest-free deferments during school.
Immediate payment. What's more, consolidation isn't a slam-dunk money saver. Stafford loans have 10-year payoffs. But lenders say the vast majority of students who consolidate choose a 20-year repayment schedule. Yes, that cuts the monthly payment in half. But the student with the longer payoff could end up paying more in total interest.
Students still in school may also find consolidation less attractive. All Stafford loans come with a grace period after graduation that allows students six months to get on their financial feet before having to start making monthly payments. Many consolidated loans demand payment straightaway, which might be a hardship if finding a job proves difficult later on. Still, experts say, the vast majority of students and parents should at least consider consolidating. After all, it frees up other cash to, say, whittle down credit card debt or buy a car needed to get to a new job, says Cheryl Watson, chief communications officer for Nelnet, a major student lender in Lincoln, Neb.
Rising rates and deadlines aren't the only reason borrowers should hurry. Alarmed by the growing costs of the loan program, Congress is considering a proposal to tie the interest rate on consolidated loans closer to the market.
No matter what happens in Congress, mounting rates are bad news for tomorrow's college students. The parents and students who were able to borrow during the past four years of cheap interest "were definitely blessed," says Michael Zimmerman, a financial planner in Eureka, Ill. Next year's crop of freshmen and parents will not only get socked by tuition increases that have generally exceeded inflation but will also have to pay thousands of dollars more on their college loans. Today's loan bargain isn't too good to be true, but it is, it seems, too good to last.
DO THE MATH
There are more details on college-loan consolidation at the government website www.studentaid.ed.gov . Calculators at www.finaid.org can help you figure out savings.
This story appears in the May 30, 2005 print edition of U.S. News & World Report.