When it was first introduced in the mid-1980s, student loan consolidation was touted as a much-needed solution for those struggling to pay their debts from college. Borrowers could combine their Stafford and Plus loans into one payment and lock in the prevailing interest rate typically, one lower than the average rates that they were previously paying on their other loans.
Times have changed, however, and consolidation is no longer the cheap and attractive option that it used to be. Thanks to the declining federal funds rate and the phasing out of variable-rate loans, consolidating your student loans now will actually cost you more over the lifetime of the loan.
Variable-Rate Stafford & Plus Loans
The rates on outstanding variable-rate Stafford and Plus loans reset every July 1 and can be found here for variable-rate loans disbursed between July 1, 1998 and June 30, 2006. Since July 1, 2006, federal loans have been fixed-rate only.
Anyone holding an outstanding variable rate loan should consider consolidating when rates are low.
In the past, all student loans came with variable rates. If a borrower had difficulty making their payments, they could consolidate their loans into one low fixed-rate loan.
But as of July 1, 2006, every Stafford and Plus loan now carries a fixed interest rate, making it unnecessary to consolidate in order to lock in a set rate. In fact, borrowers who have fixed-rate loans should never consolidate them. If they do, they'll end up with a higher interest rate than they're already paying. Under consolidation, the interest rate will be the weighted average of the rates of the loans being consolidated, rounded up to the nearest 1/8 of 1%.
Subsidized Stafford loans taken out for the 2008-09 academic year carry an interest rate of 6.0%; the rate for 2009-10 loans is 5.6%, for 2010-11% it's 4.5% and for 2011-2012 it's 3.4%. Unsubsidized loans will still carry a 6.8% fixed rate indefinitely. For Plus loans sold through the Direct Loan program, rates are fixed at 7.9%.
Standard Repayment-Period Plans
If you're really struggling to make the payments on your fixed-rate loans, consider temporarily lowering your monthly payments without stopping or postponing your payback period. (Doing so means you'll have to pay more on the back end.) Here are two plans offering a standard 10-year repayment period:
Graduated Repayment: With this plan, your interest rate doesn't change. You'll pay a small amount in the beginning as low as interest-only for the first four years and your payments will gradually increase over the life of the loan.
Income-Sensitive Repayment: This plan is available for loans distributed through the FFEL program, which was discontinued for new loans in 2010. Your monthly payments are between 4% and 25% of your monthly income. At a minimum, your monthly payment must cover the loan's interest.
Extended Repayment Plans
Think you might need more than a decade to pay off those four years of pricey liberal arts education? Then extended repayment plans while not the most attractive choice by far may be your best option. Consider a plan that extends your repayment period only if you're unable to pay off your loans in 10 years, says Holler. Any plan with a time horizon of more than 10 years, she says, will cost you a lot more.
"The goal is to find the plan that's suitable to your financial needs," says Holler. You'll need to create a budget to identify the figure that you can pay each month, and speak with your lender about what payment plan works best for you. Should you decide that an extended plan is necessary, here are the 25-year repayment options:
Income-Contingent Repayment: This plan is strictly for Stafford and Graduate Plus loans disbursed through the Direct Loan program. Payments are based on the borrower's income and debt. Monthly payments are adjusted annually as your income changes.
Income-Based Repayment: This plan goes into effect on July 1, 2009, and is available to both Direct Loan and FFEL program participants with the exception of Parent Plus loans. It pegs your monthly payment to 15% of the amount that your annual discretionary income exceeds 150% of the poverty line, divided by 12 months. The national poverty line for one person is currently $10,400 in annual income, although that varies based on where you live and the size of your family. So, under this plan, a recent graduate who lands an entry-level job making $25,600 would have a $125 monthly payment, says Kantrowitz. This payment will increase in correlation to any increases in salary that the individual receives.
The College Cost Reduction and Access Act of 2007 also provided incentives for public service work by granting forgiveness on Direct Loans after 10 years of public service employment and 120 payments made after October 1, 2007. Try FinAid.org for more details on public service loan forgiveness.
Extended Repayment: You'll qualify for this plan if you have $30,000 in student-loan debt. If you have a variable-rate loan, your interest rate will adjust throughout the life of the loan. If you have a fixed-rate loan, your interest rate and monthly payment will remain the same.
Student Loans Primer
Here's a brief description of the loans and programs discussed in this article.
Consolidation: Allows individuals to combine their federal student loans (whether they're variable- or fixed-rate loans) into one loan with one fixed interest rate and one monthly payment throughout its duration.
Direct Loan Program: Both unsubsidized and subsidized Stafford and Plus loans are available through this program, which is run by the Department of Education. The DOE sends the money to the school, and the school issues the loans to the students.
Federal Family Education Loan (FFEL) Program: Stafford and Plus loans were available through this program where loans are subsidized by the DOE and were provided by private lenders to students and their families.The program was discontinued in June 2010.
Plus loans: Graduate students and parents of undergraduate students take out these loans. Parents begin repaying these loans almost immediately (typically, 60 days after full disbursement) while the undergraduate students are in school. Graduate students can defer payments until graduation.
Subsidized Stafford loans: Students who demonstrate financial need on their Free Application for Federal Student Aid (FAFSA) which shows family size, income and assets receive these loans. The government pays for the loan's interest while the student attends school. Once they graduate, the student takes over the payments.After July 1, 2006, these loans carry a fixed rate.
Unsubsidized Stafford loans: These loans are available to students regardless of their financial status. As of July 1, 2006, they carry a fixed rate.