Low mortgage interest rates sparked a boom in home refinancing. Now low short-term interest rates could do the same for college loans.
Students graduating from college this year can "consolidate" their federally backed Stafford loans at rates as low as 2.875 percent if they do so in the next six months. Graduates beyond the six-month grace period can consolidate at 3.375 percent, while parents holding PLUS loans under the Parent Loans for Undergraduate Students program can refinance at 4.25 percent.
The rates are the lowest in 35 years, according to the U.S. Department of Education.
The loan consolidation program basically turns variable-rate student and parent loans into fixed-rate loans, and borrowers can extend the traditional 10-year repayment term to 15 years or 30 years to lower monthly payments.
"It's a real convenience," said Martha Holler, a spokeswoman for Sallie Mae in Reston, Va., one of the nation's largest college lenders. "Having a fixed monthly payment allows you to manage your money more easily."
Millions of American families are eligible. The Department of Education estimates some 7 million students and their parents get federally backed loans each year totaling some $50 billion. Many also take out private loans.
The new loan consolidation rates, which go into effect July 1, are based on a formula that keys off the yield on the three-month Treasury bill auctioned Monday. That bill carried a discount rate of 1.050 percent, with a yield of 1.07 percent. The yield a year ago was 1.12 percent.
With the Federal Reserve expected to begin raising interest rates later this year or early next year to combat any inflationary forces in the economy, the odds are that college loan consolidation rates will be higher next year.
So who should consider refinancing?
A recent study by the General Accounting Office found the average student loan debt of consolidators was about $22,000, compared with about $10,000 for graduates who chose not to refinance.
If a graduate has all of his or her loans from a single lender — whether the government or a private institution — that's the place the student must go to seek a consolidation loan. But if the student or parents have loans form a variety of lenders, they can shop around. The basic rates and terms are set by federal law, but some programs offer discounts.
Sally Stroup, assistant secretary for post secondary education at the Department of Education, said that even the federal government's consolidation program offers price breaks.
"If you consolidate with us and do payments with electronic debit, we reduce the interest rate," she said. "And we have rebates like others if you make a set number of payments on time."
There are even programs where a graduate's repayment schedule is "income sensitive," so payments start low and rise as the graduate's salary increases, Stroup said.
"There's a lot of flexibility to help people deal with these big debts," she said.
Mark Brenner, executive vice president of the College Loan Corp. in San Diego, Calif., said that five years ago, the average student debt was around $12,000. Now he's seeing people who earned both undergraduate and graduate degrees coming in with $40,000 in student loan debt.
A variety of federally backed loans qualify for consolidation, including federal Perkins loans for low-income students, and certain health education and nursing student loans. Graduates can wrap their private loans into consolidation packages, too, he noted.
The actual rate on the consolidated loan will be based on a weighted average of the outstanding loans that are included.
He estimated that a graduate with Stafford loans of $20,000 at an average rate of 5.7 percent would pay $6,310 in interest over a 10-year repayment period; a consolidated loan at 3.5 percent would reduce that interest 40 percent to $3,730.
"We're telling students graduating now that it's the best opportunity they will ever have to lock in low fixed rates for their loans," Brenner said. "And there's no prepayment penalty, so nothing prevents them from paying the loans off faster if they're able."