Graduation season is here. Which means student loan bills are close behind.
Students received an early reminder of their looming debt a few weeks ago, when a new law overhauled the federal lending program. Under the rejiggered system, the Education Department will provide all federal loans through college financial aid offices starting July 1.
Previously, families were able to obtain government-backed loans from private lenders through the Federal Family Education Loan program, or FFEL.
Students who already have FFEL loans won't be required to make any changes. But there are scenarios when it makes sense to switch over to the direct loan program.
In the meantime, the government expects to save $68 billion over the next decade or so by ending the subsidies it paid to private lenders. The savings will be used in part to boost education grants to the neediest students starting in 2013.
There are no benefits for those who already took out loans. Still, there are some payment options new graduates will want to keep in mind.
Payment plans
Graduates don't have to fear being handed a bill with their diploma; most federal loans come with a six-month grace period. But interest continues accruing during that time, so the sooner repayment starts the better.
The exception is with subsidized federal loans, in which the government waives interest charges until the loan comes due.
The standard payment option spans 10 years, but there's no penalty for paying off debt earlier. Of course, that's probably not an issue for those carrying huge debt loads.
Those pursuing fields that don't pay a lot will want to look into a program called income-based repayment, or IBR. The option was introduced last summer to help make debt more manageable. Essentially, it caps payments at 15 percent above any earnings beyond $16,000 or so. Any debt remaining after 25 years is forgiven.
Eligibility depends on a formula that weighs education loan debt against income; a calculator at www.ibrinfo.org can help determine whether borrowers qualify. Those in both the direct and FFEL programs can apply.
The new law makes IBR even more favorable, in part by capping payments at 10 percent of income. But the changes don't go into effect until 2014 and will only apply to new borrowers.
Another provision of IBR that's already in place forgives debt after just 10 years of repayment for those who work in public service. This perk is only available to those with direct loans, however. So those with a FFEL loan would need to consolidate it under the direct loan program to qualify. But more on consolidation below.
There are a couple other options for those who are struggling financially. Borrowers can apply for unemployment or economic hardship deferment for up to three years. Income needs to be around $16,000 or less to qualify for economic hardship.
And even then, interest continues piling up on the loans.
Consolidation
A consolidation loan is used to combine several federal loans, so borrowers only have to pay a single monthly bill.
Private lenders are no longer offering them, but FFEL borrowers can still get consolidation loans through the direct loan program.
A new interest rate will be based on the weighted average of the loans, so that interest charges will be about the same under a consolidation. But that average will be rounded up to the nearest 1/8 percent, so there's a small cost for the convenience of getting a single bill.
You can typically only consolidate loans after you graduate. As part of its overhaul, however, the government is letting students in school consolidate loans between July 1 and June 30 of next year if they want to deal with just one lender.
This might be tempting if you already have FFEL loans and will now get direct loans. But it's probably best to wait until you graduate, because a consolidation technically puts you into repayment, said Mark Kantrowitz, publisher of the FinAid.org.
For the same reason, watch your timing for getting a consolidation loan. If you want to take advantage of the six month grace period after graduation, hold off for a few months.
One drawback about consolidation loans is that they often extend repayment, meaning the overall cost of the loan will be higher.
This would happen if you've already been making payments on separate loans under a 10-year payment plan. A consolidation loan spreads payments over a fresh 10 years. That would reduce your monthly bill, but increase how much you pay in interest over the life of the loan.
You can negate this effect by paying off more than is due each month.
Financial bonuses are another reason FFEL borrowers might not want to consolidate into a direct loan. Private lenders sometimes offer interest reductions for a consecutive number of on-time payments, Kantrowitz said. In other cases, they may waive origination fees when you first take out a loan. Still, be aware that the fine print might stipulate that the fees have to be paid if you switch into the direct loan program.