Great News for Students With Loans

Thanks to a new ruling, students can consolidate their loans before graduating. Here's why they should do so -- soon.

THANKS TO A LOOPHOLE in the Higher Education Act that was officially approved by the U.S. Department of Education on Monday, students can now consolidate their federal student loans before graduating from college.

This is a break from the longstanding rule that students could consolidate their loans only after graduation. Historically that hadn't been especially controversial -- after all, college students are supposed to focus on their studies before graduation, not on their student loans. But with loan rates sinking to historic lows during the past five years -- and expected to rise on July 1 -- Monday's ruling could be a godsend to some cash-strapped college kids.

Undergraduate and graduate students who act before June 30 can lock in today's rate, which runs as low as 2.875%, on their existing loans, and defer payment on those loans until graduation. On July 1, the Stafford loan rate will be reset -- and it's expected to jump by as much as two percentage points.

"(Y)ou want to consolidate now, because it's going to cost you a lot more next year," says Mark Kantrowitz, publisher of FinAid.org, an online financial aid resource owned by Monster. "Not only are we now at the lowest interest rates in the 40-year history of student loans, but this two-percentage-point jump that we're facing is the biggest jump in history."

For students with high loan balances, the savings can indeed be significant. Someone with a $10,000 loan balance who plans to pay it off in 10 years would save approximately $1,100 over the life of the loan if he or she consolidates now rather than after June 30, according to Kantrowitz.

Consolidation Basics
Before you get too excited, remember that only federal loans qualify for consolidation, and only those loans that haven't been consolidated before. If you've got private loans, you're out of luck.

Here are the basics. When federal loans are consolidated, the lender pays off the existing loans and issues a new loan for the total amount. The new interest rate is the weighted average of the old loans, rounded up to the nearest one-eighth of a percentage point. So for a weighted average of 2.77% -- the current Stafford loan rate for those still in school -- the consolidation rate is 2.875%. In exchange for that slightly higher rate, borrowers get what in today's market is a fantastic deal: They turn a variable-rate loan into a fixed-rate one. In a rising-interest-rate environment, that could save you a bundle. In addition, monthly payments can be lowered by extending the loan repayment term to as many as 30 years.

A word of caution: Another type of federal loan known as a Perkins loan also qualifies for consolidation, but financial aid experts advise against doing so. Unlike Stafford loans, whose rates change each year, Perkins loans already carry a fixed interest rate -- currently 5%, explains Kalman Chany, president of Campus Consultants in New York and author of "Paying for College Without Going Broke." By consolidating a Perkins loan along with Stafford loans, you will only increase your consolidation loan rate (which, as we already mentioned, is the weighted average of all loans), and your total payment will be the same as the sum of the Perkins loan payment and the consolidated loan payment, should you decide to keep the two separate. In addition, a Perkins loan recipient might qualify for certain loan-forgiveness incentives if, after graduation, they work in fields like public-interest law or teaching in high-need areas. Those incentives don't apply to Perkins loans that have been consolidated.

For more on consolidation, including repayment options and choosing a lender, read our story.

The Trade-Off
Consolidating while still in school comes with one caveat: The student loses his or her six-month grace period after graduation. That's because in order to consolidate, the student must request from his or her lender that they enter into repayment right away, says Chany. While repayment will still be deferred, interest-free, while the student is in school, the free ride ends the day he or she graduates.

That may be a huge turn-off for students who worry that they may not be able to find a job immediately after graduation. And as you probably know, defaulting on your student loan payments -- like defaulting on any loan -- will leave a bad mark on your credit report, which might prevent you from qualifying for credit in the future. But even if the Bank of Mom and Dad can't bail you out, immediate repayment might not create a financial hardship. That's because all federal student loan lenders are required to offer the so-called forbearance option to students who are in financial distress, says Kantrowitz. Forbearance allows students to reduce their loan payments to interest-only payments, or to eliminate them completely for up to three years. All you need to do is contact your lender and complete the necessary forms. In addition, lenders typically offer a variety of repayment options, including income-sensitive or graduated repayment plans, which allow borrowers to make smaller monthly payments during the first few years of the loan, and gradually increase them in the future. With any of these options, borrowers end up paying more interest over the life of the loan. But when times are lean, it's good to know they're available.

Freshmen Might Not Qualify
The bad news for last year's freshmen and possibly sophomores is that they might not have enough in the way of loans to consolidate. Most federal student loan lenders require a minimum loan balance of $7,500 or even $10,000 in order to consolidate, according to Kantrowitz. Sallie Mae recently lowered its minimum balance requirement to $5,000.

This doesn't apply to students enrolled at direct-lending institutions -- colleges that work directly with the government to provide federal financial aid -- since the direct-loan program doesn't have any minimum requirements. But students who attend a college that offers direct lending also have no reason to be thrilled by the Department of Education's ruling -- direct lenders have allowed students to enter repayment early since the direct-lending program was created during the Clinton administration, Kantrowitz explains. (Currently, about 25% of loan volume comes from the direct lending program.) Still, consolidating while in school has never made as much sense as it does now, before rates rise. So this is a good reminder to get moving.

Lenders Not Required to Oblige
Even if you request a loan consolidation early, the lender might not agree to do it. "The guidance published by the Department of Education indicated that the lender is under no obligation to grant the request for early repayment status," says Kantrowitz. And if the lender refuses to grant early repayment status, a student can't simply go to another lender for consolidation. (Typically, if a lender is unable to consolidate a loan, the borrower is allowed to consolidate with a different lender. But this applies only to students who are already in repayment status, according to Kantrowitz. For more on eligibility for direct loan consolidation, read the Department of Education's requirements.)

But many lenders have already indicated their willingness to grant early consolidation requests. Sallie Mae has even posted a special application on its Web site.

If you can consolidate, do it now. "There's no scenario under which it isn't worthwhile," says Kantrowitz.