What the Fine Print On Your Student Loan Really Says

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The world of student loans just became more complicated and expensive for some borrowers, while others are about to get a great deal.

It all depends on whether you're borrowing now or dealing with loans from the past. Regardless, when you graduate college you should learn how you can stay out of debt.

Interest rates on variable-rate student loans will drop sharply on July 1st. That will make newer, fixed-rate loans look like a terrible deal, although for most borrowers, they're the "only deal in town."

Two years ago, Congress changed the student-loan program from a variable-rate deal based on Treasury bill rates to a fixed rate program at 6.5%. That rate now looks extremely expensive in comparison with falling interest rates in the marketplace. Still, those who have Federal student loans taken out after July 1, 2006, are stuck with those relatively high fixed-rate loans for the life of the loan.

The divergence becomes even more apparent because interest rates on older, variable-rate loans are about to be cut in half -- to 3.61% from the current 6.62% -- starting July 1. The cut comes because rates on those older loans are tied by formula to the T-bill auction that took place the last week in May.

That creates some interesting opportunities for those who borrowed in earlier years and are now graduating, as well as for graduates who have not yet consolidated their old, variable-rate loans. Not only will they get lower rates, they'll also have the opportunity to lock in those low rates for the duration of their loans.

There is some good news for current borrowers. Rates on subsidized Stafford loans taken out after July 1 will carry a fixed rate of only 6% for the life of the loan. Future cuts in new fixed-rate loans are scheduled for the next three years. But all those rates will be fixed for the life of the loan.

Loan Consolidation Rates Drop -- But No Loans Available!

There's more good news, and bad. If you're a graduating senior looking to consolidate your student loans and lock in current rates, you'll get a great deal if you wait until after July 1st. The consolidation rate on variable loans will drop from the current 7.25% all the way down to 3.625%!

The new lower rate is available only for six months after graduation, so you have to act quickly. (Those who use their once-in-a-lifetime consolidation opportunity after six months have passed since graduation, will pay a slightly higher rate of 4.25%.)

The consolidation rate actually takes into account a "weighted average" of your outstanding loans, so your rate might be slightly different.

But the really bad news is that few, if any, lenders are currently offering consolidation loans -- as a result of the current credit crunch. At SimpleTuition.com there is an online comparison tool for all kinds of student loans. But this year there are no consolidation loans to compare.

Instead there is a link to the Department of Education's Direct Loan program -- the only consolidator left in the business. With an estimated $30 billion of student loans eligible for consolidation, from this year's graduates, and past un-consolidated loans, you can be sure the government will be swamped with applicants.

(Rates for mortgages and other loans can be found at BankingMyWay.com.)

Kevin Walker, CEO of SimpleTuition.com, notes that the combination of the credit crunch, the lower subsidies on student loans and concerns about future defaults have combined to make consolidations a very unattractive product for financial institutions.

Sallie Mae (SLM), the best known student-loan provider, has also dropped out of the consolidation market.

Sallie Mae spokesperson Martha Holler points out: "There is no immediate need to consolidate as the new rates will be in effect for the next year and many other options, such as extended and graduated plans, exist to help borrowers manage student loan repayment."

Parents Get the Worst Deal

There's even more stunning interest rate news for parents who have PLUS loans: Those who took them out before July 1, 2006 will see their rates drop from the current 8.02% to 5.01%, starting in July. Those loans carry a variable rate that is also tied to the T-bill auction rate.

But parents who have taken out PLUS loans in the past two years, or who are planning to take a PLUS loan for the 2008-2009 year, will be stuck paying 8.5% -- forever (on most PLUS loans, except for those taken out directly from the Federal government at a 7.9% fixed rate).

In other words, PLUS loans have become very unattractive. But these loans, made to parents, might also be the best deal in town -- if you can find a lender. With home-equity loans tougher to get these days, and retirement plan borrowings limited by many companies, it will be difficult for many families to find, much less afford, financing for college this fall.

The Fine Print

The rates quoted above are the headline numbers. Many of today's graduates will actually pay a higher rate of interest if they can consolidate their loans. That's because this year's graduates are likely to have two years of variable-rate loans, and then two years of fixed-rate loans at 6.8%.

Since loan limits for Stafford loans were expanded over the past four years, today's grads who borrowed the maximum are likely to have the following loan portfolio after the July 1 rate change:

* Freshman year loan: $2,625 at 3.61% (the new variable rate)
* Sophomore year loan: $3,500 at 3.61% (also the new variable rate)
* Junior year loan: $5,500 at a fixed 6.8%
* Senior year loan: $5,500 at a fixed 6.8%

Remember, the consolidation rate is a weighted average of the loans you're consolidating, rounded up to the nearest one-eighth of one percent. So Simple Tuition calculates the consolidated rate for all of these loans would be 5.75%.

The question arises: why consolidate ALL your loans, if those fixed rate loans are going to be rounded up to a slightly higher rate? The only reason is to extend repayment for 15 years from the basic 10-year plan for unconsolidated loans.

Perhaps you'd want to consolidate -- and lock in -- rates on only the first two years of loans, the variable rate loans. In that case, you'd lock in the rate on those loans at 3.625% (the 3.61% consolidation rate, rounded up!). But because of the lower total amount of those loans, you'd have to pay them back in 10 years -- a good idea, anyway.

The remaining two years of 6.8% loans would carry that fixed rate, and must be repaid in 10 years, because they are unconsolidated.

Fine Print for Parents

Walker came up with an interesting twist for parents with PLUS loans: many don't realize that those can be consolidated. That might be an attractive option for the older, variable-rate PLUS loans, especially if you think inflation might drive interest rates higher in future years.

The consolidation formula is similar to that for Stafford Loans. The new 5.01% variable rate is rounded up to 5.125% -- not a bad rate to lock in. But you have until next year at this time to make that decision, so there's no rush.

Why would you consolidate the fixed-rate 8.5% PLUS loans that parents of grads have taken out in the past two years? Walker points out that PLUS loans have a maximum consolidation rate of 8.25%. So you might want to consolidate them separately through the Department of Education, to shave one-quarter of one percent off your repayment rate.

It's a very complicated, even tricky, business to deal with student loans. And that's The Savage Truth!

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