If you've already used your one-time ticket to consolidate your student loans and you're now stuck with a less than attractive rate, it pays to get creative.
That's what Aubrey Riccardi, a 30-year-old attorney at a Manhattan law firm, did. After graduating from law school in 1999, she had accumulated more than $70,000 in student loans from various lenders. Because she wanted the ease of one payment, she immediately consolidated at the going rate: 7.5 percent. However, as interest rates started to plummet, her mailbox was deluged with alluring consolidation offers, none of which she was eligible for because you can consolidate only once.
Her solution? Riccardi's parents took out a home equity line of credit, with a much lower, but variable, interest rate, which they used to pay off her loans. Now, she pays her parents monthly, and the savings have enabled her to apply money to the loan's principal each month, which cut the life of the loan from about 25 years to eight.
Riccardi is one of many graduates who have already consolidated their loans — converting their variable-rate loans into fixed-rate ones — but who are bogged down by the high interest rates they've locked in. Though options are limited, there are some alternatives for debt-laden grads to consider.
The first option, if you have built up some equity in your home, is the route Riccardi took. Lines of credit typically work like a credit card, with a limit and a revolving balance: the average home-equity line of credit currently has an interest rate of 4.81 percent, but will fluctuate in tandem with the prime rate, which is pegged to the short-term rates set by the Federal Reserve. Those rates have been ticking higher. Home-equity loans, which are received as lump sums and paid back over set periods of time at a fixed rate (now at 6.87 percent), are another option.
Another alternative, if you're refinancing your mortgage, is to do a cash-out refinancing. That's when you refinance your mortgage for more than you currently owe, in this case the amount of the higher-cost student debt, and use those proceeds to pay it off. The interest rate on a 30-year fixed rate mortgage is currently 5.76 percent, according to Bankrate.com. Another bonus? Interest is tax deductible. However, be sure to factor in all related fees, and also make sure it's a payment you can handle.
"Those are secured by the equity in the home, so the consequences of default will be pretty high," said Greg McBride, a senior analyst at Bankrate.com, adding that he'd steer clear of personal loans, which at about 14 percent carry exorbitant rates comparable to credit cards.
There are other strategies.
- Switch federal loan programs. If you're already consolidated in the William D. Ford Federal Direct Loan Program (one of the three types of student loans available through the government), you might be able to lower your rate by simply switching to the Federal Family Education Loan program, where loan holders are often eligible for certain discounts which could eventually lower their rates by up to 1.5 percent, said Dan Thibeault, president of Graduate Leverage, a student loan counseling service in Cambridge, Mass. Making on-time payments, usually for a few years, can reduce your rate by one percentage point. Signing up for the automatic bill payment program can slash another quarter of a percentage point. If loans are already part of the FFEL program, call your lender and make sure you're not missing any deals.
- Already consolidated your federal loans? Pay them off with private education loans. This strategy makes sense only if you have a pretty high interest rate, in the 8 percent to 9 percent range, and plan to pay off the loan in three to five years, Thibeault added. Rates are variable (typically pegged to prime or the London interbank offered rate), and so if they increase sharply (unlikely over that term) they could affect your rates, he added. KeyCorp, Wells Fargo & Co. and SunTrust Banks Inc. all offer these loans.
- Taking out new student loans can sometimes help. Say a grad student has money from other resources to pay the current tuition bill, but has a heap of undergrad debt at a high rate. The student can still take out the maximum amount of student loans he or she is eligible for, use the proceeds to pay off existing debt (there's no penalty for prepayment), and consolidate the new loans, locking in the current lower rate, said Mark Kantrowitz, publisher of Finaid.org, a financial aid Web site. The current interest rate of federal student loans stands at 3.37 percent for those in repayment, and it's 2.875 percent for consolidated loans still in the grace period or in deferment. The caveat is that you actually have the money to pay for the remainder of your school days.
But beware: Some students think if they take out one more student loan, they can consolidate all of their existing higher-rate loans at the lower rate.
That's not the case, because rates on consolidated loans are calculated by taking the weighted average of the interest rates on all the loans being consolidated and rounding up to the nearest one-eighth of a percent. Taking out a new loan will pull the average down only slightly, Thibeault said.