Former students who consolidate their federal student loans can now get a good education in saving money.
Consolidation rates for federal student loans with variable interest rates -- Stafford and PLUS loans originated before July 1, 2006 -- are now at the lowest levels in their history.
By consolidating, borrowers can lock in low rates for the duration of their repayment, potentially saving thousands of dollars in interest payments.
"For someone who has these loans, this is perhaps their last opportunity to get a historically low rate because I doubt it's ever going to get this low again," said Mark Kantrowitz, the publisher of financial information sites FinAid and FastWeb.
Save thousands
Student-loan consolidation wraps a borrower's federal education loans into a single fixed-rate loan. Since the rates dropped July 1, borrowers with Stafford loans who consolidate during the grace period before payments begin can lock in a rate of 2%; Stafford borrowers who consolidate once their loans are in repayment can secure a rate of 2.5%. PLUS loans, which are originated by the parents of undergraduate students, can be locked in at 3.38%.When locked in, those lower rates can potentially save thousands of dollars in interest over a loan's repayment period, Kantrowitz said.
For example, a $20,000 Stafford loan on a standard 10-year repayment with a 6.8% interest rate would require a monthly payment of $230, and the total interest paid over the life of the loan would be $7,619, he said.
But if a borrower locked in a 2% interest rate, payments on the loan would be $184 a month, and total interest paid would be $2,083 over the same 10 years. The lock-in at 2% would mean a 20% lower monthly payment and overall savings of $5,536 in interest, Kantrowitz said.
The amount a borrower can save by locking in a lower rate depends on several factors.
"A lot depends on how many dollars of loans they have at the variable rate and whether they're doing it on a 10-year term, extended repayment or other repayment plan," Kantrowitz said.
Where to apply
Because most student lenders are no longer providing federal education loan consolidation, Kantrowitz said, borrowers looking to consolidate should do so through the Federal Direct Consolidation Loans program at the U.S. Department of Education.Borrowers can apply for a consolidation loan here, and anyone thinking about consolidation who has questions should go here to learn more about the process and where to start, said Stephanie Babyak, a Department of Education spokeswoman.
"It runs through a checklist of whether consolidation is something that you as a borrower might want to consider, what's involved and how to go about it," Babyak said.
Are you eligible?
Excluding those in default, about 30% of the outstanding federal student loan borrowers have variable-rate loans and may benefit from lower interest rates by consolidating, Babyak said. As of Sept. 30, there were about 30 million federal student loan borrowers whose loans totaled about $550 billion, she said.Borrowers who have both variable-rate (originated before July 1, 2006) and fixed-rate (from July 1, 2006, forward) loans can consolidate both types, and the overall interest rate will be weighted accordingly, Kantrowitz said. By consolidating the two kinds of loans, the borrower ends up with just one monthly bill.
"You may say, 'Won't the interest rate on that consolidation loan be higher?'" he said. "It'll be higher than 2.5% but less than (your fixed-rate loan rate of) 6.8%."
Consolidation can be done only once, so borrowers who have previously consolidated their federal loans aren't eligible. Moreover, private loans and federal loans can't be consolidated together, Kantrowitz said.
Kantrowitz said that when borrowers consolidate, they often agree to a longer repayment plan than the standard 10 years because lower monthly payments seem appealing, but borrowers should be cautious because they'll end up paying more in interest over the term of the loan.
If a borrower does take advantage of the lighter monthly debt burden, Kantrowitz advises using the savings to pay off costlier loans. Otherwise, the move doesn't result in any savings.
Said Kantrowitz: "(Some borrowers) will take the smallest monthly payment available to them on the federal loans, and they won't use that extra money to pay down the more expensive debt -- they'll spend it."