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Borrowers across the country will be asking themselves how they can take advantage of this opportunity to lock in a low rate. Some will likely seek the advice of the experts in the financial aid office, as well. |
Feature... Comparing options and providing counseling can be complicated. To get started, consider the examples below. All assume that the borrower's Stafford loans were disbursed on or after 07/01/98 and have a total outstanding principal balance of $30,000. Lender incentives, student-loan interest deductibility and inflation have been factored out to illustrate the concept. Scenario one assumes that the borrower opts not to consolidate and repays under a standard ten-year term. The interest rate, 7.14%, is an average of the last four years repayment rate (1998 - 2002). Monthly payments are $350, total interest is $12,059 and the cost of borrowing is 40 cents per dollar. Scenario two assumes that a borrower consolidates during grace and requests a standard ten-year repayment term. The loans consolidated are at a 3.46 percent rate. The weighted average is also 3.46 percent and, rounded up to the nearest higher 1/8th of 1 percent, the new consolidation loan fixed rate is 3.50 percent. (Bear in mind that after grace, the repayment rate is 4.06%, which becomes 4.125 % after rounding up to the nearest 1/8th of 1 percent). Monthly payments are $297, total interest is $5,599, and the cost of borrowing is 19 cents per dollar. Scenario three assumes the same consolidation terms as scenario two, but the length of the repayment term has increased, as many borrowers opt for the longest repayment term offered when consolidating. Utilizing the maximum term available for this borrower - 20years - monthly payments are $174, total interest is $11,757, and the cost of borrowing is 39 cents per dollar. Borrowers comparing the difference in payment amounts (as much as $176 per month in our example) often choose the lowest option available. The question they must ask themselves is how would they make use of the difference? Would they pay off higher rate credit card debt or vehicle loans? Would they set the savings aside in a tax-deferred retirement annuity or save to purchase a home? Or would the savings be frittered away with nothing to show for it? While the new rates are enticing, borrowers should consider their purchasing behavior and future financial plans carefully prior to consolidating. Is it worth losing current repayment incentives? Borrowers should use their current lenders' payment plan terms and incentives as a benchmark and compare it to the benefits of consolidation. Borrowers should also be aware that if they consolidate, they lose the benefits of loan forgiveness programs for Perkins loans, but forgiveness benefits for FFEL and Direct loans remain in place. Considering the impact of inflation, the recent increase in student loan interest deductibility, and lender incentives, consolidating borrowers have a unique opportunity to obtain long-term low cost debt. It's up to them to take full advantage of the opportunities available. Other aspects of consolidation may affect school cohort default rates (CDRs). Financial aid professionals should be aware that if a borrower consolidates, the underlying loans are held accountable for the consolidation loan's behavior. Many schools select lenders based upon variables like repayment incentives and servicing. Yet a consolidating lender that may not have a relationship developed with a particular school, but still controls the servicing of the underlying loans that affect the school's CDR. Lastly, the underlying loans' repayment dates determine the cohort in which the borrower will be included. If a borrower consolidates during grace period, the anticipated repayment date (six months and one day after dropping to less than half-time status) will be replaced by the paid-in-full date. If many borrowers consolidate during grace, numbers could shift from one cohort to another and affect CDRs in the end. As a further resource, EDFUND's new publication, A Step-by-Step Look at Loan Consolidation, is available for ordering. It addresses advantages and disadvantages to consolidation, offers tips on saving money and provides handy worksheets. To view and/or order this free publication, click on "Forms & Publications" on the EDFUND Web site, www.edfund.org/schools/index.html. Order number is I-59.  |
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