Despite Pressure, Borrowers May Be Better Off Waiting With the Federal Reserve’s recent rate cuts, borrowers may be better off waiting until July 1 to consolidate their variable-rate federal student loans, although they may be feeling pressure from lenders to consolidate their loans today.

Recent graduates often opt to consolidate their loans before the end of their six-month grace period to lock in rates at the lower in-school interest rate, which is 0.60 percentage point lower than the repayment rate. For example, borrowers with variable-rate Stafford loans, which have a current repayment rate of 7.22%, could lock in a fixed rate of 6.625% if they consolidate loans within their grace period.

But if they wait until July 1, when interest rates on variable-rate federal loans reset, borrowers with Stafford loans would likely be able to lock in a consolidated rate of 6.5% or lower, says Mark Kantrowitz, publisher of FinAid.org, a financial-aid Web site. The lower rate should even compensate borrowers for having to pay the higher repayment rate of 7.22% at nine months until they consolidate — a cost that will result in about $20 for the typical student over that period, Mr. Kantrowitz estimates. “The net cost to them over the life of the loan will be lower if they wait to consolidate.”

This opportunity generally applies only to recent graduates or borrowers in repayment who have variable-rate federal loans that haven’t already been consolidated and will continue to reset annually.

Under legislation enacted last year, federal Stafford and PLUS loans issued after July 1, 2006, carry fixed rates of 6.8% and 8.5%, respectively. A student graduating in May or June of this year, for example, might have three years of variable-rate loans and one-year of fixed-rate loans, potentially making it worthwhile to consolidate the variable-rate loans.

This also assumes borrowers didn’t take advantage of the early repayment status loophole to consolidate their loans while in school. (Currently, students have to wait until after they graduate to consolidate their loans.)

Consolidating student loans is similar to the process of refinancing one’s mortgage and is typically done by students around the time they graduate. Borrowers pay off existing variable-rate loans with the proceeds of a new loan, which has a fixed rate.

For borrowers with variable-rate federal loans, the Education Department resets the interest rate on its Stafford and PLUS programs annually on July 1 using a formula based on the results of the last 91-day Treasury bill auction in May. Since rates on the 91-day T-bill tend to reflect changes in the Fed funds rate, the Fed’s recent moves to trim short-term rates a total of three-quarters of a percentage point should result in a lower interest rate on those loans.

To be sure, borrowers who wait until next year are facing the risk that interest rates rise. “If the Federal Reserve were to raise rates, then all bets are off,” says Mr. Kantrowitz. “I don’t think that’s very likely given the credit crisis and the housing market crisis.”

The consideration whether to consolidate or not comes at a time when borrowers are likely to be feeling more pressure by lenders to consolidate their loans.

After a new law took effect last month that cut federal payments to the lending institutions, squeezing profit margins on consolidation loans, lenders are trying to make up for the difference by increasing their loan volume, says Mr. Kantrowitz. He says he’s been seeing some lenders encourage borrowers to consolidate before the end of their grace period.

Due to the reduced lender subsidies, many lenders have also scaled back their borrower discounts on many of their federal loans, especially on consolidation loans. In previous years, lenders would typically offer an interest-rate reduction for making a number of on-time payments and for signing up to have payments automatically debited from a bank account.

Now, many lenders offer only an additional quarter-percentage-point reduction for signing up for automatic payments. SLM Corp.’s Sallie Mae will increase that quarter-point discount, which is offered on initial loan balances between $10,000 and $59,999, to 0.375 point if those balances are $60,000 or more on consolidation loans made on or after Oct. 1.

Another consideration: Borrowers planning to work in public service should consider consolidating their loans through the federal Direct Loan Program since they could be eligible to have a portion of their loan forgiven, suggests Kalman Chany, author of “Paying for College Without Going Broke.”

By JANE J. KIM From: www.wsj.com The Wall Street Journal

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