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Finally, after years of skyrocketing tuition costs, borrowers will get an unprecedented break on student loans.

This week, the Department of Education announced that interest rates for government-backed student loans would fall to 4.06%, a low unseen in the 37-year history of the student loan program. The rates take effect on July 1, dropping almost 200 basis points below the current rate of 5.99%, which set a historical low last year.

"This is great news for college students. People have the perfect opportunity to consolidate their loans," says Kalman Chany, author of

Paying for College Without Going Broke

Each July the Department of Education adjusts the rate on student loans. The government takes the rate of the 91-day T-bill during the last week of May and then adds a set margin of 1.7% for college students and 2.3% for those who have already graduated. Then the agency rounds the rate up to the nearest eighth of a percentage point.

This year, because of the Federal Reserve's aggressive rate cutting, the sluggish economy and the effect of September 11 on the bond markets, interest rates on the 91-day Treasury bill have dropped precipitously, Chany says.

"These rates are unlikely to go any lower, especially since the economy is showing some signs of improvement," says Mark Kantrowitz, publisher of, a Web site informing parents and students about financial aid issues. "So if you just graduated college, now is the time to consolidate your loans."

A Graduation Present

Indeed, recent college graduates will be able to take advantage of a special post-college grace period and consolidate their loans at even lower rates: below 4%.

The government gives college students a break on their loans, letting them defer payments until after graduation while their loan interest accrues at a special discounted rate. For example, instead of receiving a rate of 4.06% on July 1 of this year, college students get a 60-basis point discount, giving them an interest rate of 3.5%.

After graduation, the government continues to treat grads like active college students. For the first six months out of school, grads receive a grace period during which rates stay at 3.5% and payments are deferred. But timing is important when consolidating student loans.

If you move too quickly, for example, you could pay too soon. "Let's say you graduated in May 2002 and you race to consolidate on July 2, you'll get the low rate of 3.5%, but you'll go into repayment immediately, which means you didn't take advantage of the six-month grace period," says Greg Stringer, vice president of education lending for

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If you move too late, you could miss out on the best rates. Once the six-month grace period expires, grads lose the 3.5% rate and move to 4.06%. According to Stringer, a student who is $20,000 in debt opting to consolidate loans at 3.5% would have a monthly payment of $197.40 and a total loan cost of $23,687.66 over 10 years. "A student at 4.06% would pay $203.60 a month over 10 years with a loan cost of $24,367.33 -- almost $700 more," he adds.

Stringer advises students to wait at least three months to consolidate to avoid paying back their loans until they must, while getting the lowest possible rate. But, he warns, with so many people likely to consolidate, prepare for paperwork delays, and err on the side of caution. "The rate goes into effect when the bank processes your paperwork, not when you file the application. Consolidate by October or November," he says.

Recent grads aren't the only ones who benefit. Next year, May 2003 grads will be able to consolidate their loans at 3.5% before the rate changes in July 2003, but they'll have to forfeit their six-month grace period to do it.

Fun for Everyone

But those considering consolidation should keep in mind some pitfalls.

Borrowers in certain occupations will lose powerful perks if they consolidate. Depending on each college's financial aid guidelines, for example, up to 100% of a Perkins loan can be canceled if graduates enter certain fields, such as nursing, law enforcement or teaching in lower-income neighborhoods. A wide variety of career options have benefits, which are listed on the Department of Education's

Web site.

Some borrowers will use consolidation as an opportunity to stretch payments over 20 years instead of the usual 10, but they'll pay more in the long run. On a $20,000 debt, 20-year borrowers have a monthly payment that is $80 cheaper than 10-year borrowers, Stringer says. "But they'll pay $29,239.04 over the life of the loan," he adds. "That's about $4,900 of extra interest expense."

Because consolidating loans can't be undone or repeated, couples ending their marriages could find themselves at odds. "Both are responsible. It will have to be dealt with in the terms of the divorce," says Ray Loewe, an advisory board member for the GE Center for Financial Learning, an educational site operated by

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But despite these potential problems, after July 1, there has never been a better time to consolidate. "With these rates, I don't think it makes that much sense not to consolidate," Loewe says. has a revenue-sharing relationship with under which it receives a portion of the revenue from Amazon purchases by customers directed there from