Financial Resource Center


Timing Rules Student Loan Consolidation

by Darla Dernovsek / January 21st, 2008


Timing is everything in deciding whether to consolidate loans that finance higher education. Fortunately, time is on the side of students who will begin applying in 2008 for loans to help finance their college studies. Congress recently changed the federal interest rates for all new Stafford loans to undergraduate students to a fixed rate of 6.8% in 2007. For students who qualify for subsidized Stafford loans, that rate gradually will decrease each year to reach 3.4% in 2011. "The appeal of consolidation loans changed dramatically as a result of these changes made by Congress," says Dick George, CEO of Great Lakes Higher Education Corp., Madison, Wis. Great Lakes works with credit unions, as well as other financial institutions, nationwide to guarantee and service student loans.

Changing the rules

Congress also created an option for income-based repayment terms for students who meet income standards as part of the College Cost Reduction and Access Act. When students can demonstrate "partial financial hardship," monthly payments are limited to roughly 15% of discretionary income. This provision takes effect beginning July 1, 2009. The act also allows students to have the remaining portion of their loans forgiven if they spend at least 10 years in qualifying public service positions, such as teaching or charitable work. The program became available on Oct. 1, 2007, but only for direct loans funded by the federal government.
Timing is everything in deciding whether or not to consolidate student loans.
Students who move their Federal Family Education Loan Program (FFELP) loan into the direct loan program through loan consolidation also qualify, but that option is not available until July 1, 2008. The 10-year employment period and 120 months of required payments began on Oct. 1, 2007, for direct loan borrowers and begin on July 1, 2008, for students consolidating other types of student loans into the direct loan program. Students who may benefit from the loan forgiveness provisions in the future should be wary of trading them in for a consolidation loan now, as student loans only can be consolidated once. In addition, students should be aware that consolidating loans might cause them to lose benefits offered by lenders, such as credit unions that participated in the FFELP to offer student loans in 2007 and earlier. Under the rules in effect when those loans were made, FFELP lenders earned more on student loans, which they often shared with borrowers in the form of discounts, such as lower interest rates for borrowers making prompt payments. Many lenders eliminated those discounts when Congress made changes in 2007 that reduced the money lenders earned on student loans.
Private loans account for one-fifth of student loans.
"Those borrower benefits are lost if they consolidate," George notes.

Using existing options

Student borrowers sometimes seek to consolidate—or combine student loans issued in multiple years or by multiple lenders into a single loan—as a way to lengthen the loan repayment term and to decrease monthly payments. George says these students often are unaware that a longer repayment term already is an option on federally backed student loans. Under existing rules, borrowers who took out their first loan on or after Oct. 1, 1998, and who have high balances, can extend the repayment term for as much as 25 years, with the potential repayment term based on the amount of all student loans. These changes mean that borrowers have much to think about before agreeing to consolidation offers conveyed by glossy brochures that typically arrive in the mail as graduation nears. "There are more questions for borrowers to ask based on their individual circumstances than there were in the past," George says.
You lose some borrower benefits if you consolidate.

Choosing to consolidate

Traditionally, students sought to consolidate multiple student loans into a single obligation for two reasons, according to Joe Orsolini, owner of College Aid Planners, Glen Ellyn, Ill. First, these students might have been seeking relief from rising interest charges on federal student loans with variable interest rates. By obtaining a loan with a fixed interest rate, they froze the monthly payment amount and protected themselves from future interest rate increases. The changes Congress made mean that this benefit of consolidation is limited to students who obtained loans in 2007 or earlier. As long as interest rates remain relatively low, even students with variable rate loans may find that their gains are slight. A decrease in the interest rate of 1% for a student with a total loan obligation of roughly $20,000 would affect payments by $10.50 a month. A calculator on the Great Lakes site helps students figure the amount of savings. Timing also is important to get the best interest rate for borrowers with variable interest rate federal loans. The interest rate on federally backed loans is based on the U.S. Treasury bond auction held the last week of May. That rate takes effect on the following July 1, giving borrowers a little more than a month to decide if it's more favorable to consolidate under the current rate or wait until the new rate takes effect on July 1.
A longer repayment term already may be an option.
"Keep an eye on what the market is doing," Orsolini says. "Timing is everything here." The second motive driving many student borrowers who seek consolidation is combining all student loans into one monthly payment for convenience. Instead, students seeking an alternative to consolidation might consider automated payments to send funds to loan accounts on a specified date each month.

Private loans

The College Cost Reduction and Access Act will not affect students who borrowed to pay for education costs through "alternative loans," also called "private" loans because they are not part of the federal program. Federal consolidation loans can be used only to consolidate federally backed loans, so private loans must be consolidated through private alternatives. A list of federally backed loans is provided on the Great Lakes Web site under its "Consolidation FAQs."
Student loans can be consolidated only once.
Private loans account for about one-fifth of all money borrowed for higher education, according to the Project on Student Debt. In response to the growing use of private loans, more lenders are offering private consolidation loans. A student with a good credit rating may find this option attractive, according to George. "If you got stuck with bad private loans the first time out, there may be some private consolidation options out there for you," George says. Orsolini says students who want to combine all their loans into one repayment sometimes use a private consolidation loan to handle both federal and private loans. Hybrid loans are rarely a good deal, however, because they usually charge higher interest rates than the student's existing federal loans.

Ten and out

Interest rates on federally backed student loans typically are much lower than rates for car loans or credit card debt. While that means student loans usually are regarded as "good debt," Orsolini notes that it still makes sense to repay the loans in a timely manner. Repaying debt within the traditional 10-year window can benefit borrowers by getting the obligation out of the way before life events such as marriage, raising children, and buying a house increase expenses. Orsolini recently met with a 49-year-old professional seeking help to finance the college education of his daughters while still repaying his own student debt. "A 10-year payback on a student loan is a good time frame," Orsolini says. "The more debt you can pay off, the better you'll be prepared for other life events."
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