Consolidating student loans lower rate gets tougher

When college alumni show up for homecoming weekend and hold forth about how much better things were when they were in school, it's usually the beer talking. But graduates who boast about the great deals they got on their federal student loans probably aren't exaggerating. As recently as three years ago, savvy borrowers who consolidated their loans were able to lock in rates as low as 2.88%.

In late 2005, though, Congress set a fixed rate of 6.8% for Stafford loans, the most popular kind of federal student loans. If you have federal loans issued after July 1, 2006, consolidating will no longer affect the interest you pay.

That doesn't mean the benefits of loan consolidation have completely disappeared. If you're graduating this spring, you may still have loans issued before July 1, 2006. Consolidating those loans, which still carry a variable rate, would enable you to lock in a rate below 4% for the life of those loans, says Mark Kantrowitz, publisher of FinAid, a financial aid website.

But snagging that low rate won't be easy. Among the challenges:

•Timing your consolidation. To take advantage of falling rates, you must wait till July to consolidate your loans. Rates for variable student loans are adjusted every July 1, based on the rate for Treasury bills at the last auction in May.

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Kantrowitz predicts that the rate for variable-rate loans will drop to about 3.75% on July 1, down from the current variable rate of 6.62%. If the Federal Reserve decides to cut short-term rates at its meeting Wednesday, he says, the rate for variable loans could fall even further on July 1.

Graduates who consolidate during their grace period — the six-month window before they have to start repaying their loans — could lock in a rate of about 3.12%, Kantrowitz says.

•Finding a lender. In the past, lenders battled for consolidation loans, offering borrowers discounts and other perks. Now, those perks are gone, along with most of the loan consolidators. A handful of lenders still offer loan consolidation, but Kantrowitz predicts they'll all leave the business before July 1.

The credit crunch and a reduction in federal subsidies for student lenders have made those loans unprofitable, he says. "Every time a lender makes one of these loans, it's taking a loss."

Fortunately, borrowers who can't find a private consolidator can consolidate through the government's Federal Direct Loan Program.

There are two types of federal student loans. One type, Federal Family Education Loans, is offered by private lenders and guaranteed by the government. The other: Federal Direct student loans, which the government offers directly to students at schools that take part in the direct lending program.

Even if your loans come through the FFEL program, you can consolidate them through the Federal Direct Loan Program, Kantrowitz says. You can find more information at www.loanconsolidation.ed.gov.

In the loan pool

Though you can include your fixed-rate loans when you consolidate, there's no financial benefit to doing so, Kantrowitz says. The rate for your consolidation loan is based on the weighted average of all the loans you consolidate, rounded up to the nearest one-eighth of 1%. Which means you can't lower the rate on your higher-interest loans by including them in the loan consolidation.

If all your loans carry fixed rates, there's no benefit to consolidating them, either. Consolidating fixed-rate loans will actually raise the rate slightly, to about 6.88%, Kantrowitz says. If you're looking to lower your monthly payments by extending the repayment term, consult your lender. You may be able to negotiate an extended repayment plan without consolidating your loan, Kantrowitz says.

One other thing to keep in mind: Because borrowing limits on federal loans haven't kept up with tuition inflation, students are increasingly turning to private loans to cover their college costs. Be aware that these loans typically carry variable rates, aren't guaranteed by the government and can't be included when you consolidate your federal student loans.

Some private lenders let borrowers consolidate their private loans and lock in a fixed rate. But the fixed rate is often 1 or 2 percentage points higher than current variable rates, Kantrowitz says.

In addition, some private consolidation loans impose prepayment penalties and other fees that could add to the cost of the loan, says Kevin Walker, CEO of SimpleTuition, a website that lets borrowers compare rates for student loans.

"If I were a borrower, I would be skeptical," he says. "I would lean toward not consolidating my private loans."

Consolidating student loans at a lower rate gets tougher
by Sandra Block
Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays