Interest rates on federal variable-interest student loans fell to historically low levels by July 1, 2009, to the benefit of many undergraduates. Those who had waited until then before consolidating their older variable-rate loans would have saved thousands of Dollars in interest over the term of the loans.
Variable and Fixed-rate Loans
Federal PLUS and Stafford loans divide into two categories:
Education loans that originate before July 1, 2006 feature varying rates that reset every July 1, in line with 91-day T-Bill investment rate auctions held the previous May. These would continually reset every year, unless and until borrowers lock in terms by having their loans consolidated. Importantly, rates on such loans had fallen to historically low levels by July 1, 2009.
Education loans that originate from July 1, 2006 onwards feature fixed rates of interest. An unsubsidised Stafford loan features a 6.8% rate, whereas a PLUS loan features a rate of 7.9% (Direct Loan programme) or 8.5% (FFEL programme). Subsidised Stafford loans for students also feature fixed interest rates, although later ones were pegged at differing rates, due to the phased reductions in rates effected from 2008 to 2009.
Under the 2007 College Cost Reduction and Access Act, the fixed rate was 6.0%, while from 2009 to 2010, the rate fell (for newer loans originating from July 1, 2009) to 5.6%, 4.5%, and 3.4%, before a reversion to 6.8% without Congressional extension of the changes. Subsidised Stafford loans in graduate programmes then continued to feature 6.8% interest.
Locking in the Advantages of Newer Variable-interest-rate loans
The previous 91-day T-bill rate auction held on May 26, 2009 had established the investment rate of 0.178%, which yielded the variable rates that were effected on July 1, 2009, as follows:
- Stafford Loans (Grace periods/in-school): 1.88%
- Stafford Loans (Repayment periods): 2.48%
- PLUS Loans: 3.28%
The new rates were 1.727% lower than the previous ones in effect from 2008-2009. These were the lowest interest rates on student loans in the history of the Federal programme. The last low was recorded during the years 2004 to 2005, when grace period/in-school rates for Stafford loans fell to 2.77%.
Borrowers benefited from the ability to lock in the applicable rate on such variable-rate loans, after consolidation. These had fixed interest rates, representing the weighted averages of the currently applicable rates for all loans under consolidation, which were rounded up by a 1/8th point and then capped at an 8.25% rate.
Students with variable-rate loans that were consolidated after July 1, 2009 thereby benefited from the lowered interest rates, as follows:
- Stafford Loans Consolidation (Grace periods/in-school): 2.00%
- Stafford Loans Consolidation (Repayment periods): 2.50%
- PLUS Loans Consolidation: 3.38%
The Bottom-Line Benefit
Students who still had variable-rate loans at that point had been wise to wait for July 1, 2009 before consolidating.
Exceptions to the Rule and Caveats
Undergraduates who already had their federal student loans consolidated before that point could not benefit from the historic fall in interest rates, for any further of relocking rates is not allowed. Students with loans that originate after July 1, 2006 typically were simply not eligible for these newer, lower interest options, since these were only possible with a variable-rate loan.
Furthermore, private education loans could not be consolidated along with Federal loans. In any case, a borrower who remained in school could not pursue the option before graduation, since Congress had repealed the early repayment loophole back in 2006.
Students who availed of prompt-payment discounts from lenders would lose them once they opted for loan consolidation. Borrowers availing of up-front loan discounts, including fee waivers, would likewise be affected, given certain terms and conditions. Nevertheless, the savings derived from locking in the low rates generally outweighed the value of such foregone discounts.
Borrowers were advised to not include any Perkins loan in consolidations, as they would thereby forego the subsidised interest, along with the forgiving terms linked to these loans. As interest rates are already fixed, there is no advantage to including Perkins loans.
Similarly, no financial advantage derives from including a fixed-rate student loan alongside a variable-rate loan in any consolidation loan, except perhaps by the masking of some of the 1/8th-point rounding-up, which depends on loan balances. Where the weighted average maintains the underlying borrowing costs to some extent, there is no disadvantage to including a fixed-rate PLUS or Stafford loan with a variable-rate loan in consolidation. Borrowers would consider the option as well for its simpler repayment scheme.
For those who opted to consolidate their loans, there is no further requirement to move from regular ten-year repayment plans to longer options, including extended or even income-based schemes of repayment. Some students may have switched to these alternative plans to make the most of the low rates. But if they did, it was to exploit the reduced monthly payments towards paying down their costlier debt. If not, they would have only raised their interest costs over the term of their loans.