This week, Gail offers advice on how to deal with rising interest rates on college loans.


Dear Gail-
I’m graduating from college at the end of this month and I’ve been told I need to do something with my student loans because the interest rate is going up. (I’ve got two and my parents have one, but I don’t know if this affects them, too.)

Can you please explain this?
Thanks,
Diane

Dear Diane —
First of all, congratulations on earning your college degree! That’s a major accomplishment.

The good news is you don’t need to be a math major to understand this issue: On July 1st interest rates on the most popular student loans are going up significantly.
If you act before then, you can save yourself — and this includes your parents — a bundle of money.

Two separate forces are at work:

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Rising Interest Rates

Interest rates have gone up considerably over the past year. Because existing “Stafford” (student) loans and “PLUS” (parental) loans have variable interest rates, these are going to head higher when the rates are re-set July 1st.

As you can see from the chart below, the rates on these loans currently range from 4.7 to 6.1 percent. Since they are based on the the 3-month T-bill, we won’t know how much the rates are going up until the Treasury auction takes place in late May.

But according to Bob Kling, who works in the Borrower’s Services division of the Department of Education , “We expect the rate on Stafford loans to increase by 1.6 percent to 1.9 percent, which would push these rates close to 7.0 percent.”

In other words, if you’re currently paying the in-school rate of 4.7 percent on your Stafford loan , on July 1st your cost of borrowing this money will go up by more than 30 percent!

Similar increases are expected on variable rate parental PLUS loans .

Federal Legislation
The other factor affecting student loan interest rates is a piece of legislation passed by Congress earlier this year. Among other things, the “Deficit Reduction Act” cuts the amount of federal money available for student loans by about $12 billion.

This Act also replaces the variable interest rates on new student loans — those issued after June 30th — with “fixed” rates. (Existing Stafford or PLUS loans with variable rates will continue to have these adjusted up or down annually.)

Stafford loans issued after this date will carry a fixed rate of 6.8 percent, whether you are in school or not. The rate on parental PLUS loans issued by a private lender of Sallie Mae under the Federal Family Education Loan (FFEL) program will jump to 8.5 percent; the rate increases to 7.8 percent if the money comes through the federal government’s “Direct Loan” program.

Interest Rate Interest Rate
Loan Type Status Today July 1st
Stafford (students)(Direct Loan or FELF Program)
in-school or grace period 4.7%(variable) 6.8%(fixed)
repayment 5.3%(variable) 6.8%(fixed)
PLUS FELF Program n/a 6.1%(variable) 8.5%(fixed)
Direct Loan n/a 6.1%(variable) 7.8%(fixed)


Consolidate and Save!
While there is not much you can do if you will need to borrow college money after June 30th, you can at least lock in the interest rate on any existing loans by consolidating them into a single loan with one lender.

In other words, consolidation converts the rate on your loan from “variable” to “fixed” based on the interest rates currently in effect. “Suppose you’re a dentist with a $50,000 student loan at 5.3 percent and in repayment,” says Kling. If you consolidate, “you can lock in that 5.3 percent because it will probably go to 7 percent July 1st.”

If you’ve got multiple college loans, the rate on your consolidation loan will be based on the weighted average of all the loans you’re combining.

A good place to educate yourself about this is the website of the Department of Education. It is the main page for information on federal grant and loan programs. When you get there, click on “repaying.” On the next page that comes up, scroll down to the section on loan consolidation where you’ll find a link to additional information.

You’re free to consolidate with any lender you want, although it makes sense to check with your current lender(s) to see what they are willing to offer. According to Kling, “The only incentive the federal government’s Direct Loan program offers is it drops the interest rate by a quarter of a percent on a consolidation if you elect to have payment electronically debited from your bank account.”

Private lenders, such as banks, have more “wiggle” room to cut you a deal. Many will shave off an additional quarter of a percent — or more — to get or keep your loan on their books. (The rate set by the federal government is the maximum lenders can charge; they’re free to charge less.) Some will reduce your rate even further once you have made three years’ worth of on-time payments.

Depending upon the deal your lender is prepared to make, you can conceivably reduce your interest rate by a full percentage point or more.

In-School Consolidation to End
It’s also possible to consolidate your loans even if you’re still attending college.

But not for long.

Thanks to the Deficit Reduction Act , after June 30th all in-school consolidations are eliminated. The only time you’ll be able to consolidate your college loans will be after you graduate.

Technically, in-school consolidations can only be done if at least one of your loans were issued through the “Direct Loan” program or if you attend a college that participates in this program- something your financial aid office can tell you.

“If you’re a sophomore and want to take advantage of this, you can lock in the in-school variable rate of 4.7 percent and retain your grace period when you graduate,” says Kling. “In addition, your consolidated loan retains its in-school deferment.”

Translation: At least you can make sure some of your student loans don’t experience an interest rate hike on July 1st. Moreover, you’ll still have the benefit of your payments being delayed until 6 months after you graduate.

But what if your loans didn’t come from the Direct Loan program and your college isn’t a participant?

Because of strong demand from students who are still in school, some private lenders are offering “quasi” in-school consolidations. According to Kling these lenders have gotten “creative”: they’ll agree to consolidate all existing loans a student has if s/he gives up her/his “grace period.”

The problem with this is your loan payments will start right after you graduate instead of six months later.


Consolidate and Keep Your Grace.. Period
There’s a surprisingly simple way around this.

Even if your student loans are from the private sector, you can consolidate through the Direct Loan program online. All you have to do is tell the Department of Education that you considered the terms your private lender offered and weren’t satisfied with them.

“The student essentially self-certifies that they’ve looked at consolidating their loan with their lender, didn’t like the terms, and prefers the Direct Loan program,” says Kling.

Time is Running Out
No matter what type of consolidation you’re considering, the most important thing is to start the paperwork. The terms you get are based on when you apply for a consolidation loan, not the date it’s granted.

As of the latest count, there are $391 billion in student loans outstanding. If the interest rate on that amount rises by just one percentage point that equates to nearly 4 billion dollars in additional interest paid!

This may be the single most important lesson about handling credit that you learn from going to college: Don’t be stupid. Don’t miss the deadline.

Hope this helps,
Gail

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