10 February 2005

Consolidate While You Can

This is long, and maybe boring, but very useful if you have student loans and you haven't yet done a magical thing called "consolidation." I can't link it because the Wall Street Journal won't let you in without a password, so here it is in full. But I've bolded the important bits, cause I'm nice like that.

Program to Ease Student Debt Is in Jeopardy
Budget Proposes Ending Funds For Popular Consolidation Loans;
A Window for Refinancing


By JOHN HECHINGER
Staff Reporter of THE WALL STREET JOURNAL
February 9, 2005; Page D1

President Bush's new budget proposes scrapping a popular program that has allowed college graduates to save thousands of dollars in interest payments over the life of their student loans.

In recent years, millions of people have signed up for the government-backed program, which lets them consolidate multiple borrowings into a single fixed-rate, low-interest loan.

Now, with interest rates rising and concern growing in Washington about the cost of these subsidized, federally guaranteed loans, many experts have advice for debtors who haven't yet consolidated: Do it now. Congress, spurred in part by the president, could eliminate these loans as early as next year.

In this week's budget proposal, the Bush administration said it favors doing away with the loans to free up money for other efforts, such as increasing the amount new students could borrow and grants available for low-income students. Such a change would have a big impact on how affordable college loans are. Spurred by rising rates, borrowers consolidated $43.7 billion worth of student loans in the year ended Sept. 30, more than three times the amount four years earlier.

For recent grads, new consolidation loans generally have a fixed rate of 3.375%, with terms as long as 30 years. Lender discounts and other incentives can lower that over time to 1.625% -- as close to free money as most borrowers can hope to find. On average, college graduates have about $16,000 in student loans, while the recipient of a professional degree carries four times that much.

Finance companies such as SLM Corp., better known as Sallie Mae, and Collegiate Funding Services Inc. are bombarding former students with fixed-rate offers, and those who consolidate now could save a lot of money. That's because rates on standard student loans are variable - that is, tied to prevailing interest rates - so they will increase as other rates do. The Bush proposal would allow consolidation loans only at variable rates.

Momentum is growing to shut down the fixed-rate loans. U.S. Rep. John Boehner, the Ohio Republican who chairs the Committee on Education and the Workforce, recently introduced a bill that would eliminate fixed-rate consolidation loans. The concern is that taxpayers will be responsible for a costly and growing obligation as interest rates increase.

During the past decade, loan consolidations have resulted in a $3 billion-plus windfall for taxpayers, because lenders have to pay special fees to the government on all consolidation loans. Regular student loans don't include those fees. But a variety of studies have concluded that, with rates rising during the next few years, lender fees will no longer compensate for the billions of dollars in required subsidies.

That's because the Education Department guarantees a minimum return to student-loan lenders that is tied to prevailing interest rates. If interest rates continue to rise as expected -- and students lock in historically low interest rates -- the government will have to pay bigger sums to lenders to continue subsidizing the consolidation loans.

In the political calculus, college financial-aid officers generally support scrapping fixed-rate loans because they want to preserve or expand benefits for students about to enter college. Student groups -- and many Democrats -- fiercely support the consolidation program as one of the key ways government makes higher education more affordable.

Mike Portell, 23 years old, a recent graduate from Purdue University, consolidated $11,000 in student loans last month with Sallie Mae. His rate, locked in for 15 years, is set at 2.875%, with monthly payments of $75. Mr. Portell, an analyst with consultant Accenture Ltd. in Chicago, says he jumped at the chance to refinance once he realized it was an option. "How much lower can it get?" he adds.

To understand consolidation, it helps to get a handle on how student loans work. In school, students generally borrow each year, either directly from the government or, more often, through big lenders, such as Sallie Mae or banks.

Generally, students don't have to make payments while in college or graduate school or during a six-month grace period after graduation. Then, for a standard loan, they have 10 years to pay back the money. Once a year, the government sets the interest rate, tied to that of Treasury securities; it's now at a record low 3.37%. By law, the rate can't rise above 8.25%.

The government first allowed consolidation in the 1980s, figuring that the convenience and the option to extend payments over 30 years would help lower default rates. At the time, all student loans had fixed rates.

But, in the early 1990s, Congress instituted variable rates for student debt, except for consolidation loans, which are currently fixed at the average of a student's current loans, rounded up one-eighth of a percentage point.

Under federal rules, graduates can generally consolidate only once. Because many students got burned locking in high interest rates, some lawmakers have proposed allowing multiple consolidations. This week, President Bush in part backed that approach, though the rate would be variable and repeat consolidators would have to pay a 1% origination fee, making it somewhat less attractive.

The change would be a boon for borrowers like Allison Waterworth. A psychologist in San Francisco, Ms. Waterworth, 35, took out about $90,000 to get her doctorate at the Florida Institute of Technology in 1997. A year later, she consolidated all her loans with Sallie Mae at a rate of 8.25%. As she has struggled to pay them off, receiving various deferments, the balance has grown to $172,000, with monthly payments of nearly $1,250, about half the rent on her apartment. "This interest rate is killing me," she says.

For graduates with standard loans, there's no time to waste. If Congress approves Rep. Boehner's bill, it would take effect in July 2006. Also this July, the Education Department will reset all student-loan rates to reflect rising interest rates. So students may never again see the current deal. Assuming a graduate has already started to make payments, the rate is now 3.375%. If a student consolidates during the six-month grace period before payments are due, the rate drops to 2.875%.

Lenders will also sweeten the offer. Sallie Mae and Collegiate Funding, for example, will knock off a quarter of a percentage point of annual interest for those who sign up for direct withdrawals from bank accounts. After 36 on-time payments, the companies will drop the rate another percentage point. That would bring the rate to 1.625%.

Sandy Baum, a Skidmore College economist and senior policy analyst at the College Board, suggests that most graduates should still seek to repay student loans in 10 years -- rather than the longer period allowed on most consolidation loans. That way, they won't still be paying them off when their own kids go to college.

"It's tempting for people to stretch out the payments longer than they should," she says. "That's the only pitfall for students."

Write to John Hechinger at john.hechinger@wsj.com


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Borrowing by Degrees
The average college graduate, with $16,400 in college loans, could save thousands by consolidating now.

Type of Loan -- Rate -- Monthly Payment -- Total Payments
Standard 10-year loans -- Variable, currently 3.37%, rising to 6.9%* -- $161 to $185 -- $21,769
Consolidation loan (10-year) -- 2.63% -- $155 -- $18,644
Consolidation loan (15-year) -- 2.63% -- $110 -- $19,858

*Based on interest-rate forecast by Congressional Budget Office.

Note: These rates are for a student who consolidates in the six-month "grace period" after graduation, and before payments are due. Rate also reflects a discount for electing to have payments automatically deducted from a bank account.

Source: Sallie Mae

2 comments:

Tommy said...

This is such a smart thing to do. When I started paying towards my student loans the rate was about 7% back in 2001. When I went for my masters, I deferred my loans again and took out some more loans at 3%. When I finished my masters, I had 6 different loans at both high and low rates so I consolidated them into 2 loans at 3% and I am paying LESS per month now than when I was paying towards them in 2001. Definitely consolidate!

Tommy said...

This is such a smart thing to do. When I started paying towards my student loans the rate was about 7% back in 2001. When I went for my masters, I deferred my loans again and took out some more loans at 3%. When I finished my masters, I had 6 different loans at both high and low rates so I consolidated them into 2 loans at 3% and I am paying LESS per month now than when I was paying towards them in 2001. Definitely consolidate!