The interest rates on older variable-rate federal education loans dropped to new historic lows on July 1, 2009. This will save borrowers who waited until July 1, 2009 to consolidate variable rate loans thousands of dollars of interest over the life of their loans.
Variable vs. Fixed Rate Loans
Federal Stafford and PLUS loans fall into two groups:
Locking in the New Variable Interest Rates
The last 91-day T-bill rate auction in May occurred on May 26, 2009 with an investment rate of 0.178%, yielding the following new variable rates that went into effect on July 1, 2009:
These rates are 1.727% lower than the interest rates in effect in 2008-09, and are the lowest interest rates in the history of the federal student loan program. The previous low was in 2004-05 when in-school/grace period rates on the Stafford loan hit 2.77%.
Borrowers can lock in the current applicable rate on variable-rate loans by consolidating them. The interest rate on a consolidation loan is a fixed rate that is the weighted average of the current applicable interest rates on the loans being consolidated, rounded up to the nearest 1/8th of a point and capped at 8.25%.
Thus borrowers with variable rate loans who consolidate them after July 1, 2009 obtain the following consolidation loan interest rates:
Bottom Line Advice
Borrowers who still have variable rate loans should wait until July 1, 2009 to consolidate their loans.
Potential Savings
Consolidating variable rate loans after July 1, 2009 saves thousands of dollars in interest over the life of their loans.
For example, compare the cost of a $20,000 Stafford loan with a 6.8% interest rate (the current fixed rate and also the historical average interest rate) with the cost of a variable rate Stafford loan with the interest rate locked in at 2.0%. The monthly payment on the 2.0% rate loan over a standard 10-year repayment term is $184 and the total interest paid over the life of the loan is $2,083, compared with $230 and $7,619 on a 6.8% rate loan. This represents a 20% lower monthly payment and total interest savings of $5,536 (73%). Over an extended 20-year repayment term the monthly payment on the 2.0% rate loan is $101 and the total interest paid is $4,282 compared with $153 and $16,640 on the 6.8% rate loan. That represents a one-third (33%) lower monthly payment and total interest savings of $12,358 (74%).
Compared with consolidating at the current grace period rate of 3.635%, the savings are still substantial. A borrower with $20,000 in variable-rate debt who consolidates after July 1, 2009 saves $1,790 (46%) in interest over the life of a 10-year loan and $3,865 (47%) in interest over the life of a 20-year loan and will benefit from a $15 to $16 reduction in the monthly payment.
How to Consolidate Your Loans
Since most federally-guaranteed student loan program lenders are no longer consolidating federal education loans, borrowers who wish to consolidate their loans should use the Federal Direct Loan Consolidation program at loanconsolidation.ed.gov.
Exceptions and Caveats
Borrowers who have already consolidated their loans cannot take advantage of the drop in interest rates, as it is not possible to relock the rates after the loans have been consolidated. Borrowers with loans originated after July 1, 2006 are not eligible for the new lower rates, as these rates are only available to borrowers with varaible rate loans. Private student loans cannot be included in a federal consolidation loan. Borrowers who are still in school cannot consolidate their loans until they graduate, as Congress repealed the early repayment status loophole in 2006.
Borrowers who received prompt payment discounts from their lender will lose those discounts if they consolidate. Borrowers who received up-front discounts on their loans, such as fee waivers, may lose those discounts if they consolidate, depending on the terms of the discounts. However, generally the savings associated with locking in the loans at historically low interest rates will outweigh the value of the lost discounts.
It is not advisable to include Perkins loans in a consolidation loan, as one loses the subsidized interest and favorable forgiveness benefits associated with a Perkins loan if the loan is consolidated. Also, since the interest rate on the Perkins loan is already fixed, there is no financial benefit to consolidating them.
Likewise, there is no financial benefit to including fixed-rate federal education loans in with variable rate loans in a consolidation loan (other than possibly masking a portion of the 1/8th of a point round-up, depending on the loan balances). However, to the extent that the weighted average preserves the underlying cost of the loans, there is also little harm in including fixed rate Stafford and PLUS loans in with variable rate loans in a consolidation loan. Borrowers may wish to consolidate the loans together to simplify the repayment process.
There is no requirement that a borrower who consolidates his or her loans switch from standard ten-year repayment to a longer repayment plan, such as extended repayment or the new income-based repayment plan. Some borrowers may choose to use extended repayment to maximize the term of the historically low interest rate. However, if they do so, they should use the reduction in the monthly payment to pay down more expensive debt. Otherwise they are merely increasing the amount of interest they will pay over the life of the loan.
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| Type | Today | Week Ago |
|---|---|---|
| 15 Year Fixed | 4.62%  |
4.67% |
| 30 Year Fixed | 5.15% | 5.15% |
| 1 Year ARM | 3.48% |
3.51% |
| 5/1 Year ARM | 3.62% |
3.68% |
| Type | Today | Week Ago |
|---|---|---|
| Line of Credit | 4.89%  |
4.88% |
| 10 Year Loan | 7.47% | 7.47% |
| 15 Year Loan | 7.61% |
7.60% |
| Type | Today | Week Ago |
|---|---|---|
| Interest Checking | 0.28% | 0.28% |
| Money Market/Savings | 0.38% | 0.38% |
| 12 Month CD | 1.13%  |
1.15% |
| 60 Month IRA CD | 2.40% |
2.41% |
| Type | Today | Week Ago |
|---|---|---|
| Cash Back Cards | 12.66% |
12.68% |
| No Annual Fee Cards | 12.08% |
11.97% |
| Reward Cards | 12.75% |
12.61% |
| Small Business Cards | 11.01% |
10.94% |
| Student Cards | 13.77% |
13.49% |
| Platinum Cards | 12.26% |
12.11% |
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It REALLY sucks that current borrowers are stuck with the very high fixed interest rates - 8.5% for PLUS loans (plus a hefty 3% origination fee and 1% guarantee fee) whereas for those who borrowed before 2006 the rate is only 3.28% - this seems very, VERY unfair...
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It is unfair, but the 3.28% rate is more the anomaly. Congress never expected interest rates on variable rate federal education loans to drop that low, which is one of the reasons why they passed the switch to fixed rates. If one ignores the unprecedented decreases in interest rates since 9/11, the overall average PLUS loan interest rate for variable rate loans was about 7.9%. A fixed rate of 8.5% is still rather good for unsecured debt. For example, Bankrate.com listed the interest rate on a $30,000 home equity loan at 8.8% fixed on June 9, 2009. The PLUS loan interest rate is lower despite the lack of collateral and is available to more borrowers.
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I believe you make a good point about the comparability of rates between education loans and other unsecured debt. However, from a risk standpoint I believe that education loans are safer from bankruptcy than a home equity loan could be. It is especially safer than signature loans such as credit cards. It is my understanding that judges generally do not reduce education loans through bankruptcy, though I may be mistaken.
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You are correct that a qualified education loan is much more difficult to discharge in bankruptcy than a home equity loan or line of credit. The only way to get a student loan discharged is to file an undue hardship petition, which is a very difficult standard. (There's a pending US Supreme Court case that may modify this, however.) But if you default on a home equity loan or line of credit, you will lose the home. If you default on a student loan, they can't repossess your education. Moreover, you are much more likely to repay the debt as per the agreement than to default on the debt, so cost of the loan should be a more important consideration than dischargeability. (If you choose the higher cost loan, though, you will probably increase the odds of a default. The primary predictors of default are interest rates -- to the extent that they affect the size of the monthly payment -- graduation rates and job placement rates.)
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All of my loans were taken out for graduate school after July 1st, 2006 and are fixed(Subsidized and Unsubsidized Stafford Loan, Graduate Plus). I have $130,000 in loans but fortunately have a job that pays me $70,000 a year, entry-level. Should I go on the standard repayment plan with no consolidation? Or should I consolidate now? I was thinking of going on the standard repayment, paying off each month as much as I can, and then consolidating when interest rates go back down on my loans. Any advice is appreciated.
Thank you!
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Since your loans were borrowed after July 1, 2006, they all have fixed rates. The interest rates are never going to "go back down". Your decision as to whether or not to consolidate should not depend on interest rates. The main reasons some borrowers might consolidate include simplifying the repayment process (one loan payment a month instead of many) and access to alternate repayment plans.
If all of your loans are with the same lender, you can get 25-year extended repayment without consolidating. If you were to consolidate the loans (at loanconsolidation.ed.gov), you could get up to 30-year extended repayment, graduated repayment or income-contingent repayment in addition to standard repayment. Also, starting July 1, 2009, a new repayment plan (income-based repayment) becomes available. Income-based repayment is like income-contingent repayment, but involves a lower monthly payment and is available regardless of whether you consolidate or not.
With $130,000 in loans and $70,000 in income, you have a debt to income ratio of almost 2. You didn't say how much are Stafford and how much are Grad PLUS, but it's probably about an even split. That suggests that the total of your monthly education loan payments on a standard 10-year repayment plan will be about $1,550, or 27% of your income. You may find it a bit of a struggle to manage, but if you can, it will be worthwhile. You might want to have the monthly payments auto-debited from your bank account since you'll feel the pain of the payments less if the money is transferred automatically.
But if you find it too difficult to afford the monthly payments on your salary, look into alternate repayment plans. A 25-year repayment plan would cut the monthly payment to about $975 and a 30-year repayment plan to $922, and income-based repayment to around $670, but all of these would significantly increase the total interest paid over the life of the loan. (And do you really want to still be repaying your own student loans when your children graduate from college?)
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How does this affect the interest rate on subsidized Stafford loans if i pay off the interest while I'm still in school?
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I see your point Mark (re: high fixed rate on PLUS loans compared to those for the lucky pre-2006 borrowers), but the 3% origination fee for the PLUS loan, on TOP of the 8.5% rate is a killer as well. Unfortunately, we don't have much home equity... But if we could borrow a bit against home equity, should we try to do so? What about a variable rate home equity line of credit as opposed to a fixed rate? Our EFC is about 25% of gross income, which is going to be very tough - will definitely need to borrow a good portion of that. (Then there's the very complicated issue of how much to cut back on our retirement contributions to husband's 403(b) plan vs. borrowing for kids' education - we're 53 years old. It gets to be hard to sleep at night worrying about all this stuff.)
I agree with the President that, for student loans, we need to eliminate the middleman and go back to having direct subsidized loans like in the 70's. (My loans, and I had only a small amount - the '70s being probably the golden era of need-based financial aid - were at 3%). I don't know if that was ever the case (direct loans) for educational loans to parents (like the PLUS program), but that would be a nice touch as well. The middle and upper-middle classes are really getting priced out of higher education. College costs have risen so much more than wages over the past 3 or 4 decades that it is ridiculous.
(sorry for the long delay in replying -- new here, and just today received an e-mail about updates to this thread...)
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I have the opportunity with my local bank where I have my mortgage to pay for my graduate doctoral program with a line of credit much like an equity loan at 5%. This is for a $35K loan, over a two year span. I can repay the interest every six months during that period, and repayment doesn't begin until I am finished with coursework (two years). I neglected to ask about origination fees. Does this sound like a better deal than a Stafford unsubsidized and/or a Graduate Plus loan?
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Given the 5% interest rate, this sounds like a variable rate home equity loan or line of credit, not a fixed rate loan. You need to confirm whether the interest rate is fixed or variable. The 6.8% interest rate on the unsubsidized Stafford loan and the 7.9%/8.5% interest rate on the Grad PLUS loan are both fixed rates. Variable rate indexes like the LIBOR index and Prime Lending Rate are likely to increase over the next few years. If this 5% interest rate is variable, it is likely that it could increase to 9% or 10% or more a few years from now.
If the 5% interest rate is fixed and cannot be increased by the lender, and there are no fees, it would appear to be less expensive than the federal education loans. However, be sure to read the promissory note carefully, as I've seen a few examples recently of supposedly fixed rates that can be changed by the lender at any time, especially fixed-rate credit cards. Also, keep in mind that the federal education loans have a variety of flexible repayment benefits that you won't be able to get from a second mortgage. Keep in mind that if you default on a mortgage, you can lose your home, while if you default on an education loan, they can't repossess your education.
If the 5% rate is a variable rate, it is only a better deal if you are capable of repaying the debt in full within a few years and intend to do so. Otherwise the fixed rate federal education loans are a better deal.
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