To Tell Students to Consolidate or Not to Consolidate . . .
That is the Question as Student Loan Interest Rates Get Set to Rise
By Ken Garrett, American Student Assistance® (ASA)

We knew the good times couldn’t last forever. Interest rates influenced by the federal government are slowly creeping upward, and it looks like federal student loan interest rates will be no exception.

To understand why student loan interest rates are expected to go up, we first have to identify how the rates are established. Federal Stafford and PLUS Loan interest rates are variable (although they cannot exceed 8.25 percent) and are set annually each July 1. These rates are determined by adding a certain percentage to the bond equivalent rate of the 91-day Treasury bill (T-bill) auctioned at the final auction on the last business day in May.

Last year Stafford and PLUS interest rates hit an all-time low—2.77 percent for current students and recent graduates; 3.37 percent for Stafford borrowers in repayment; and 4.17 percent for PLUS borrowers.

Since that time, the 91-day T-bill rate has been steadily rising, and economic prognosticators say it won’t come down anytime soon. “Shorter-term bills that are controlled by the federal government, such as the 91-day T-bill, are rising faster than long-term bonds,” explains Betsy Mayotte, ASA director of privacy and compliance, “and there are no signs to indicate a reversal of this trend in 2005.”

Even if short-term rates don’t rise any higher than their current levels, the 91-day T-bill right now is still significantly higher than it was last summer. Last year by June 1 the T-bill rate was at 1.07 percent; today it is approximately at 2.3 percent.
“Regardless of whether or not the federal government raises rates over the next five months, there would still be an approximate increase of one percentage point in student loan interest rates based on today’s numbers,” says Mayotte.

What does this increase translate into in actual dollars? The average student loan borrower has a total cumulative balance of roughly $17,000. The total monthly payment amount, based on an interest rate of 4 percent and a standard 10-year repayment term, would be $172 and the borrower would pay a total of $3,564 in interest. If rates were to rise by one percentage point to 5 percent, that same borrower’s monthly payment amount would increase to $180 and the total interest paid over the life of repayment would be $4,637 – a difference of more than $1,000.

Interest Rate	Total Loan Debt	Monthly Payment	Total Interest Paid
4%	$17,000	$172	$3,564
5%	$17,000	$180	$4,637

So with all indicators pointing to higher interest rates, the next logical question for student aid administrators is, “Should I advise my students to take advantage of consolidation?” But like so many other issues in the often-confusing world of financial aid, this question does not have a black or white answer.

“Consolidation Loans have their pros and their cons,” cautions Mayotte. “While consolidation may be an effective and necessary repayment solution for some students, for others it can be a short-term fix that ends up being more costly in the long run.”

Here are some facts to consider when counseling your students on choosing consolidation:

What is consolidation and how can it benefit borrowers?
When a borrower consolidates his student loans, his separate individual loans are paid off by the consolidating lender and one new loan is created. The terms for this new loan will generally range between 12 and 20 years, rather than the standard 10-year term on the borrower’s existing loans. By having longer to pay the loan off, the borrower is allowed to make a lower monthly payment amount. Another advantage (and the benefit that will be touted the most in coming months because of the expected interest rate rise) is that Federal Consolidation Loans have fixed interest rates, versus the variable rates of all other Federal Family Education Loans. The interest rate on a Consolidation Loan is determined by taking the weighted average of the borrower’s current loans' interest rates and rounding up to the nearest one-eighth of a percent. By consolidating, the borrower ensures that for however long it takes to pay the loan off, the interest rate will never change. This means that, assuming student loan interest rates go up over the next few years, the borrower will save money in interest.

And here’s an added wrinkle to the “to consolidate or not to consolidate” debate: the upcoming reauthorization of the Higher Education Act may include a proposal to switch the interest rate on Consolidation Loans from fixed to variable. “The historic low interest rates of the past few years, which we’ve never seen before in the industry, are causing concern that the federal government is losing too much money on Consolidation Loans ,” states Mayotte. “For borrowers considering consolidation, this could be a strong argument for pulling the trigger now instead of waiting.”

Who should consolidate?
Borrowers who have multiple loan payments and excessive loan debt are the ideal candidates for a Consolidation Loan. If borrowers have numerous monthly payments to different servicers and record keeping is a huge hassle, consolidation can streamline the process because they need only make one payment to one company per month. Additionally, if the total amount of a borrower’s monthly payments is more than his budget can allow, he should look to a Consolidation Loan for a lower monthly payment.

What are the drawbacks of consolidation?
The longer repayment term of a Consolidation Loan means the borrower will pay more in interest over the life of the loan. Borrowers are charged interest on the outstanding balance—so the longer they take to pay, the more they pay. However, this scenario is favorable to borrowers potentially falling behind on student loan payments because they are unable to make the minimum monthly requirement or become overwhelmed with paperwork. Additionally, borrowers can counteract the longer repayment term/more interest combination by pre-paying or accelerating payment (there is no pre-payment penalty on student loans). Another potential drawback of consolidation is that the borrower may lose out on some repayment benefits or loan forgiveness options, since consolidation loans are not always eligible for these special programs.

When should borrowers consolidate and who should they contact to start the process?
Borrowers should first discuss consolidation with their existing lenders. Lenders who do not consolidate should be able to recommend another lender. While interest rates and terms will not vary between lenders, some may offer incentives (such as interest rate reductions for on-time payments) to their customers that others do not. Borrowers should “shop around” for these incentives before deciding on a consolidating lender.

Borrowers interested in consolidating should be encouraged to start the process ASAP. The projected rising interest rates will most likely spark a huge consolidation rush, so borrowers should make every effort to have paperwork completed and submitted by May 1. A good rule of thumb may be to tell them to think of tax day (April 15) as their consolidation deadline, too.

FFELP guarantor American Student Assistance® (ASA) helps your students and parents secure student loan financing and successfully manage debt after school. By giving education loan borrowers the right information at the right time, through proactive outreach and education, we help them achieve on-time loan repayment and overall financial wellness. If you would like to know more about how ASA can help you educate your students, contact Ken Garrett, ASA’s Southern account executive, at kgarrett@amsa.com or 404-442-9739.