The Student's Guide to Study Loans & Consolidation

From The Wall Street Journal Online

The math may be changing on student loans.

Lawmakers are considering a revamp to the federal student-loan program that
would add a new option into the mix: adjustable-rate loans. On the flip side,
fixed-rate loans may soon become more expensive.

The changes, wending their way through Congress, could be good news for future
students. For years, there was only one choice for graduates looking to consolidate
all of their student loans into a single loan: a fixed rate that was locked
in for good and couldn't be refinanced. Ask anyone who consolidated in the mid-1990s
-- when student-loan rates were north of 8% -- how they feel about that these
days and you'll get an earful.

With the proposed changes, students would still only have one crack at consolidation,
but they would have the option of choosing an adjustable-rate loan. Loan rates
would adjust annually as interest rates rise and fall.

These days, though, rates are rising. Which brings me to the bad news: If the
legislation is passed as is, locking in today's still relatively cheap rates
with a fixed-rate loan will cost you more.

How much more? Currently, the rate you pay on a consolidated loan represents
the weighted average of your loans rounded up to the nearest one-eighth of a
percent (capped at 8.25%). That formula would still stand with the adjustable
choice. But under the proposed rules, if you choose a fixed-rate loan instead,
the government would tack on a percentage point. Plus, you'll get hit with a
0.5% origination fee. Currently, there is no fee on consolidation loans.

The upshot: If you're thinking about consolidating to a fixed-rate loan, now's
the time -- before interest rates rise further or these changes become law.

"Everybody who was inattentive enough not to have consolidated by July 1 should
probably do so now, because when these changes roll in it's going to cost them
a lot more," says Barmak Nassirian, a spokesman for the American Association
of College Registrars and Admissions Officers in Washington, D.C.

Lawmakers got a step closer to updating the federal student-loan program last
week when the House Committee on Education and the Workforce approved a bill
that would update the Higher Education Act. Lawmakers aren't expected to vote
on the legislation, or a similar bill in the Senate, until the fall.

"This issue is one of my top priorities, and I'm optimistic the House and Senate
will work together to enact meaningful reforms ... by the end of the year,"
says Rep. John A. Boehner (R., Ohio), chairman of the committee.

Preserving Rates

The changes have been proposed as a way to shift spending on financial aid.
Because student loans are subsidized, the government must make up the difference
between the student-loan rate and the rate lenders charge when interest rates
rise. By introducing an adjustable-rate loan option, lawmakers hope to pass
some of that cost onto the borrower.

Federal student loan rates re-set annually on July 1 and are tied to the yield
on the 91-day Treasury bill, which has been rising in line with the Federal
Reserve's federal-funds target rate, according to John Canavan, bond-market
analyst at Stone & McCarthy Research Associates in Princeton, N.J.

The fed-funds rate currently stands at 3.25%, up from 1% a year ago. "We're
looking for the rate to end the year at 4.25%," Mr. Canavan says.

If you took out loans over the last few years when rates were at record low
levels and you haven't consolidated yet, consider preserving those rates for
yourself now, college administrators say.

The best consolidation rate that borrowers of Stafford loans would qualify
for stands at 4.750%, up from 2.875% last year, for students still in the "grace
period" that borrowers are allowed before they have to start paying back their
loans. For loans already in repayment, the rate is 5.375%. The Parent Loans
for Undergraduate Students (PLUS) stands at 6.125%, up from 4.25%, according
to SLM Corp., better known as Sallie Mae.

Even undergraduates should consider whether consolidating their loans now makes
sense, rather than waiting until after graduation. As this
article explains, more schools have been urging students to consolidate
loans while they're still in school to benefit from the current low interest-rate
environment. Still, most students who consolidate loans while still in school
lose the grace period. Discuss options with your lender to be sure you have
the resources to make your monthly payments while still in school, or if the
lender offers deferred-payment plans or forbearance until you're financially
able to begin making payments.

Know What You're Getting Into

Under the current rules, if all of your loans are with one lender, you must
consolidate your loans with that lender. If, however, you have loans with several
lenders, or if you have loans directly from the Department of Education, you're
free to comparison-shop for consolidation loans.

Most schools provide a "preferred lender list," says Mark Kantrowitz, founder
of financial-aid information Web site FinAid.org in Cranberry Township, Pa.,
and many banks will offer special incentives for borrowers who sign up for automatic
bill-payment, use a lender's Web site features or make on-time payments. As this
article explains, banks and lenders recently sweetened some of these "borrower
benefits" amid growing competition in the consolidation business.

For example, Sallie Mae recently changed its "Cash Back" incentive so that
borrowers could qualify for cash-back rebates on consolidated loans more quickly
than before. Now borrowers receive the rebate after signing up for the company's
online account management tool and making 33 on-time payments -- before the
lender required 48 on-time payments before issuing a rebate. With Cash Back,
on a $40,000 consolidation loan charging the highest rate of interest allowable
(8.25%), a borrower could qualify for up to $1,320 cash rebate.

But check the terms and conditions of these incentives carefully. Mr. Kantrowitz
of FinAid.org notes that many students eventually trip up with on-time payments,
disqualifying borrowers from the benefits.

Tom Joyce, spokesman for Sallie Mae, says few students do eventually qualify
for incentives because they don't understand the basic terms of the loan, including
the rate and the monthly payment. "Borrowers need to think about their own behavior,
what they're likely to qualify for, and whether or not they think they're able
to make on-time payments," he says. The most frequently missed payment is the
first one, because students tend to move before the repayment plan starts and
they don't receive the bill, says Mr. Joyce says.

Finally, consolidating loans may not be the right choice for some borrowers.
The government will forgive all or part of federal education loans if the borrower
becomes a teacher in certain fields or low-income schools, or performs certain
types of public service work, such as military service or volunteer work. If
you consolidate, you may lose that chance at forgiveness --check the fine print.
For a state-by-state listing of teaching positions that qualify for loan forgiveness,
click here, and check out FinAid.org for details on other loan-forgiveness programs.