July 1 Interest Rate Reset Looming For Borrowers Considering Loan Consolidation
By Rick Robey, President, Sallie Mae Southeast Region Sales

The clock is ticking for borrowers who want to lock in today’s low interest rates by consolidating their student loans. On July 1, interest rates on federally guaranteed education loans will be reset, and analysts predict that those rates may rise for the second-straight year in a row—as much as 1.5 to 2 full percentage points over the current rates. Borrowers who consolidate at today’s interest rates—the fourth-lowest in the 40-year history of the program—could potentially save hundreds or even thousands of dollars over the life of their loan.

Considering Consolidation
Federal student loan consolidation helps borrowers manage their education loan repayments by combining eligible loans into a single, new, federally guaranteed loan—a Federal Consolidation Loan—with a longer repayment term and a single monthly payment.

Borrowers who apply for consolidation before the July 1 interest rate reset can potentially lock in an interest rate as low as 4.75 percent for the duration of their repayment period. In addition, many lenders offer borrowers who consolidate special discounts for making on-time payments or paying via direct debit.

Moreover, student loan companies often offer private consolidation loans to students who wish to increase the repayment time on their private/alternative loans, or decrease the number of payments they make each month. With a private consolidation loan, borrowers can consolidate their non-federal education-related debt and education-related credit card debt. This type of consolidation loan can be very useful for borrowers; however, they are not federally guaranteed.

It is important that student borrowers consolidate all their federal student loans first and separately. Other loans can be consolidated at a later date. This is recommended because consolidating federal education loans allows borrowers to combine outstanding loans into one and reflects a positive payment history. This “payoff” of outstanding loans improves the borrower’s credit score, which can help the student get a better interest rate on a credit-based private consolidation loan.

The Deficit Reduction Act
With the signing of the Deficit Reduction Act of 2005 earlier this year, new Stafford Loans will have a fixed interest rate of 6.8 percent and new PLUS Loans, a loan for parents which was expanded to graduate and professional students, will have a fixed interest rate of 8.5 percent.

It is important to remember that the Deficit Reduction Act did not make any changes to the terms of existing loans issued before July 1, 2006. That means existing Federal Stafford and PLUS Loans will continue to have variable interest rates, and the interest rate will change each July based on the formulas outlined in federal statute.

Consolidation continues to be a readily available debt-management tool for borrowers with one or more eligible loans. The legislation did not alter the current interest rate formula, which remains the weighted-average rate of the loans being consolidated, rounded up to the nearest one-eighth of a percent, with a cap of 8.25 percent. Currently, customers can lock in rates as low as 4.75 percent if they apply by June 30.

In addition, no changes have been made to key terms of federal consolidation loans. Borrowers may still take up to 30 years to repay, depending on the total level of their education indebtedness; there are no fees of any kind; credit checks are not required; and there are never prepayment penalties. Consolidation loans also remain eligible for deferment, forbearance and loan cancellation benefits.

Legislative Changes
However, Congress has instituted several new rules that do affect federal loan consolidation, one of which tightens existing restrictions on the reconsolidation of existing consolidation loans.

Under the new rules, borrowers who have only a single consolidation loan may not reconsolidate, unless they are experiencing serious payment stress and only if they seek to consolidate under the Direct Loan Program and sign up to repay their loans under an income-based plan. But borrowers will still be able to reconsolidate an existing consolidation loan if they have any additional federal loans to include in the new consolidation loan.

Last year, temporary guidance from the U.S. Department of Education opened the consolidation door to current students by allowing them to put their loans into an early-repayment status while still in school, which made the loans eligible for consolidation. The Deficit Reduction Act ends this practice as of July 1, 2006.

Until then, current students can request early-repayment consolidation by contacting their lender to lock in today’s low interest rates on at least a portion of their student loans; freshmen typically will not have the minimum balance required to consolidate their loans so they likely are not affected. Starting this July, borrowers may only consolidate loans that are already in grace, repayment, deferment or forbearance status.

Finally, to secure maximum savings, it is important that students and families pay close attention to key dates. Interest rates on Stafford and PLUS Loans will change on July 1, not a day before. While it is important to start the consolidation application process in plenty of time to meet the June 30 deadline, borrowers should beware of any marketing materials that suggest an earlier timeframe.