If You Have Student Loans, Read This

Kevin Walker, CEO of SimpleTuition.com, notes that the combination of the credit crunch, the lower subsidies on student loans and concerns about future defaults have combined to make consolidations a very unattractive product for financial institutions.

Sallie Mae(SLM Quote), the best known student-loan provider, has also dropped out of the consolidation market.

Sallie Mae spokesperson Martha Holler points out: "There is no immediate need to consolidate as the new rates will be in effect for the next year and many other options, such as extended and graduated plans, exist to help borrowers manage student loan repayment."

Parents Get the Worst Deal

There's even more stunning interest rate news for parents who have PLUS loans: Those who took them out before July 1, 2006 will see their rates drop from the current 8.02% to 5.01%, starting in July. Those loans carry a variable rate that is also tied to the T-bill auction rate.

But parents who have taken out PLUS loans in the past two years, or who are planning to take a PLUS loan for the 2008-2009 year, will be stuck paying 8.5% -- forever (on most PLUS loans, except for those taken out directly from the Federal government at a 7.9% fixed rate).

In other words, PLUS loans have become very unattractive. But these loans, made to parents, might also be the best deal in town -- if you can find a lender. With home-equity loans tougher to get these days, and retirement plan borrowings limited by many companies, it will be difficult for many families to find, much less afford, financing for college this fall.

The Fine Print

The rates quoted above are the headline numbers. Many of today's graduates will actually pay a higher rate of interest if they can consolidate their loans. That's because this year's graduates are likely to have two years of variable-rate loans, and then two years of fixed-rate loans at 6.8%.

Since loan limits for Stafford loans were expanded over the past four years, today's grads who borrowed the maximum are likely to have the following loan portfolio after the July 1 rate change:

• Freshman year loan: $2,625 at 3.61% (the new variable rate)
• Sophomore year loan: $3,500 at 3.61% (also the new variable rate)
• Junior year loan: $5,500 at a fixed 6.8%
• Senior year loan: $5,500 at a fixed 6.8%

Remember, the consolidation rate is a weighted average of the loans you're consolidating, rounded up to the nearest one-eighth of one percent. So Simple Tuition calculates the consolidated rate for all of these loans would be 5.75%.

The question arises: why consolidate ALL your loans, if those fixed rate loans are going to be rounded up to a slightly higher rate? The only reason is to extend repayment for 15 years from the basic 10-year plan for unconsolidated loans.

Perhaps you'd want to consolidate -- and lock in -- rates on only the first two years of loans, the variable rate loans. In that case, you'd lock in the rate on those loans at 3.625% (the 3.61% consolidation rate, rounded up!). But because of the lower total amount of those loans, you'd have to pay them back in 10 years -- a good idea, anyway.

The remaining two years of 6.8% loans would carry that fixed rate, and must be repaid in 10 years, because they are unconsolidated.