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For student loan borrowers, it's that time of year again. They're being bombarded with letters and e-mails urging them to consolidate their loans. And with federal student loan rates poised to go up by nearly 2 percentage points on July 1, consolidation may seem like a no-brainer. But as any business major knows, financial decisions aren't one-size-fits-all, and consolidation, which locks in a long-term fixed rate, may not be the right decision for everyone.
Following the recent overall rise in interest rates, rates for Stafford loans and Parent Loan for Undergraduate Students (PLUS) will be the highest in six years when they reset at the end of the month. Stafford loans for students still in school, within a six-month grace period after graduation, or in deferment, will see interest rates rise from 4.75% to 6.54%.
Stafford loans already being repaid will go up from 5.375% to 7.14%. For parents who took out a PLUS loan, the interest rate will climb to from 6.14% to 7.94%. With consolidation, their interest rate becomes the weighted average of all loans rounded up to the nearest eighth of a percentage point.
LOCK IT IN. Basically, consolidation is a bet on the direction of interest rates. And while no one knows for sure where rates will go in the future, many experts say the rate that borrowers can get now is relatively low and will not decrease substantially in the near future. "Interest rates won't go down. Six-and-a-half percent, historically is a good return," says Marilyn Steinmetz, a certified financial planner with Mutual Service Associates in Avon, Conn. "We've had unusually low interest rates in terms of fighting deflation and recession."
Pat Scherschel, vice-president of loan consolidation for lender Sallie Mae (SLM), says that in a historical context, it is hard to make a case that rates will soon drop to the low levels of the past few years. "Could they? Yes. Will they? That's the bet you make, but those who see no immediate reason for rates to decline in the next few years would be best to lock in current rates," she says.
Another deadline is a pending change in the consolidation rules. June 30 is the last date that students can consolidate their loans before graduation. Starting July1, only graduates can consolidate. How do you know if consolidating is right for you? If all loans are taken out with the same lender, the borrower must consolidate with that lender. If loans are with different lenders, the borrower may choose to consolidate with any of those companies.
REWARDING BEHAVIOR. While the government requires that all lenders offer the same interest rates, some provide better benefits to borrowers. "Know what your benefits are. Decide whether they are important for you or not," says Larry Burt, director of the Office of Student Financial Services at the University of Texas at Austin .
Many lenders offer rebates for on-time payments. For instance, Sallie Mae -- which serves 10 million borrowers -- gives an immediate quarter percentage point rate reduction for paying via direct debit and a 1% rate reduction after 36 months of on-time payments. If students apply now, they can save about $5,000 in interest payments on the life of a $20,000 loan over a 20-year period -- assuming rates on Stafford loans do not fall -- and $3,400 more if they qualify for borrower benefits, says Scherschel, of Sallie Mae.
If students consolidate online with Nelnet (NNI) -- another lender -- they can choose a 1% interest rate reduction after 36 initial on-time payments or a one-time 3.33% principal reduction for 30 initial on-time payments.
FROM THE SOURCE. Another benefit could be coming from your university. Direct Loan schools -- which account for about 35% of loan volume in the United States and get their funding for students taking out loans from the U.S. Department of Education instead of a non-governmental company -- give borrowers an upfront interest rebate of 1.5%.
"Many of the private bank consolidation lenders have been soliciting consolidation from our students and they usually don't touch on the fact that we'll give you this benefit," says Beth Oakes, associate director of financial aid at the University of Iowa -- a Direct Loan school. Oakes is not promoting consolidation, though she says it "makes sense" in some cases.
The average student leaves college with $30,000 in loan debt, according to a survey by AllianceBernstein Investments (see BW Online, 6/05/06, "Mom? Dad? I'm Home!"). "In the vast majority of cases, if you have borrowed $10,000 or more or a parent has borrowed $10,000 or more, you need to do serious investigation [of consolidation]," says Texas's Burt, who is also associate vice-president of student affairs at the school.
RULE OF THUMB. The downside to consolidation? If students choose to consolidate, they can elect to have more time -- in some cases up to 30 years instead of the typical 10 -- to pay off debt. Smaller monthly payments might be a godsend for recent alumni who cannot afford large payments or find jobs. However, by stretching out the loan, students may eventually pay more in interest. Also the hassle and confusion that may come with consolidation is often not worth it for students with a relatively small amount of debt.
Before consolidating, undergraduates leaving B-school should think about their salary-to-loan repayment ratio. According to the CollegeBoard.com, a rule of thumb is that a new grad's monthly student loan repayments should not exceed 10% to 15% of starting monthly income.
At the same time, business majors are entering a strong job market this summer (see BW Online, 3/21/06, "The Jobs Come Looking for Grads"). Many students are also leaving school for $40,000 or $50,000-plus salaries and decent bonuses, which could allow them to pay off debt in a shorter period of time. That way they can avoid paying interest for more years than necessary.
All in all, if you're looking to have some stability and do not think interest rates will get better, consolidation is a gamble that might be worth taking.
Gordon is a reporter for BusinessWeek.com in New York
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