Student Loans Get More Expensive

The government will reset interest rates for federal Stafford and PLUS loans this summer, and it's expected to bump them up by as much as 1.5 to two percentage points, according to industry experts. This would be the first rate increase in five years — and probably not the last.

Interest rates for Stafford and PLUS loans are reset each July 1, based on the 91-day T-Bill rate determined at its last auction in May. Last year, the T-bill hit a rock-bottom 1.07%. Stafford loans for students in repayment were at 3.37%. After a series of Federal Reserve interest rate hikes since then, however, the T-bill is expected to approach 3% in May. At its latest auction in March, it traded at 2.84%. The Stafford loan rate, were it to be set today, would be 5.14%.

"At this point, it's a no-brainer from a student perspective: You want to consolidate before July 1 in order to lock in the current rates," says Mark Kantrowitz, publisher of FinAid.org, an online financial aid resource owned by Monster.

Crunch the numbers, and you'll see what's at stake. A May 2005 graduate who owes $20,000 in Stafford loans could save more than $4,300 in interest by consolidating them before July 1 vs. consolidating afterward , according to Sallie Mae, the nation's largest educational loan provider. And borrowers already in repayment or parents with PLUS loans could save nearly $5,000. (For details, see the tables below.)

Sweetening the appeal of consolidation are a number of bills introduced in Congress over the past year that propose switching the fixed consolidation loan rate to a variable rate. Should Congress pass the bill — and it likely will, says Kantrowitz — new fixed-rate consolidation loans would be gone by July 2006.

Here's a quick tutorial on consolidating your loans.

How It Works
If you've got a private loan, you're out of luck. Only federal loans qualify for consolidation, and only those that haven't already been consolidated before. You can, however, combine a consolidation loan with a new loan. (For example, a graduate school loan can be consolidated with previously consolidated college loans.) Among the qualifying loans are subsidized and unsubsidized Stafford loans, Perkins loans, PLUS loans, and other federal educational loans, like Federal Nursing Loans.

When you consolidate your qualifying loans, the lender basically pays them off and gives you a new loan for the total amount. The new interest rate is the weighted average of the loans you are consolidating, rounded up to the nearest one-eighth of a percentage point. (For more on that, see How Lenders Calculate Your Rate.) You can also consolidate a single loan on its own, using its own rate as the weighted average. This means you will be paying a slightly higher interest rate: For example, if your weighted average is 2.77% — the current rate for Stafford loans during in-school and grace periods — your consolidation rate will be 2.875%. For a weighted average of 3.37% — the rate for Stafford loans in repayment — your consolidation rate will be 3.375%.

In exchange for this slightly higher interest rate, you gain two major benefits. One, you lock in a low fixed interest rate at a time when rates are expected to continue rising for the near future. And two, you're able to extend your repayment term and thus lower your monthly payments. The flipside to this is that you'll pay more in interest over the life of the loan, but you can always prepay the loan with no penalty.

How Lenders Calculate Your Rate