Here are some things to consider before you decide to consolidate your variable-rate student loans.
1) One of the most compelling reasons to consolidate now is that Federal loan interest rates, which are based on recent T-bill rates, are at close-to-historical lows — 3.625 percent for a loan in its grace period, 4.25 percent for a loan in repayment and 5.125 percent for a PLUS loan, compared to last year’s rates of 6.8 percent, 7.2 percent and 8.02 percent, respectively.
This means that, even though your variable-rate loan interest will go down anyway after July 1, there’s no guarantee that interest rates will remain this low in subsequent years. If you consolidate now, you can lock in a low rate no matter what happens to interest rates later.
2) Even though your payments might go down after consolidating, how much are you really saving? For example, if you have $20,000 in loans with a variable rate, your payment based on the rates that expire on July 1, 2008, would be about $234 a month for 10 years, paying a total of $8,114 in interest. If you consolidate those loans now, you would lock in a rate of about $205 a month for 10 years, paying a total of $4,585 in interest.
Where this decision gets tricky, however, is figuring out how your variable-rate loans will change in future years.
If those rates go up by 1 percent next year (and never drop below that again for the life of the loan), your payment (without consolidating) would go up to at least $214 a month and your total interest would be a least $1,000 more. If those rates go up 2 percent (and never go down), your monthly payment would go up to at least $223 and your total interest would go up at least $2,000. If the variable rates stay about the same for the next 10 years, your payments and total interest paid would also stay relatively constant.
3) Unfortunately, if you have any fixed-rate Federal loans, which are likely to have rates well above the new variable rates, consolidating those loans won’t save you much, if any, money.
That’s because the formula for figuring the rate of a consolidated loan is based on the already established weighted average rates of all the loans involved, rather than on the new variable rates. If you have both variable- and fixed-rate loans — all Federal loans disbursed on or after July 1, 2006, are fixed-rate loans — then you can still consolidate your variable-rate loans and take advantage of the new rates.
4) If you have both Federal and private loans, make sure to consolidate them separately. Private loans have higher interest rates than the Federal loans (both initially and in consolidation), so mixing them can end up raising the rate on the money you borrowed through a Federal program. In general, private loan consolidation plans are based on the Federal Prime interest rate or the London Interbank Offered Rate, both of which, after a private institution adds its own points to the equation, are substantially higher than Federal consolidation rates.
5) It’s important to remember that each situation is different, and that the advice given here is only meant to provide general guidelines about how to proceed. If you are considering refinancing, contact your lenders directly for the details specific to your needs and ability to pay.