3.6% student loans: Consolidate now

By Liz Pulliam Weston

People who haven't yet consolidated their variable-rate federal student loans have a great opportunity to do so: The interest rates on these loans just plunged 3 full percentage points.

As of July 1, consolidating allows you to lock in excellent rates of 3.62% to 4.25% on Stafford Loans and 5.13% on PLUS Loans for graduate students and parents.

If you have $20,000 in variable-rate federal Stafford debt, for example, that rate drop could save you nearly $30 a month, or more than $3,500 over the 10-year life of the consolidated loan.

"It's a no-brainer," said Mark Kantrowitz, the publisher of FinAid.org and a co-author of "FastWeb College Gold: The Step-by-Step Guide to Paying for College." "If you have variable-rate loans, consolidate them."

Great, right? Except there are a few glitches. Namely:

The once-competitive consolidation market has evaporated. Thanks to the credit crunch and to changes Congress has made in student loan funding, virtually all student loan consolidators, including Sallie Mae, have abandoned the market as unprofitable, Kantrowitz said. But you can still get your federal loans consolidated through the U.S. Department of Education.

The new rates apply only to variable-rate federal loan debt. Federal loans issued after July 1, 2006, all have fixed rates. You can't lower the rate on that debt, but you can consolidate it with your variable-rate loans to get one payment and an extended payback period (a repayment plan that stretches for 20 or 30 years instead of 10, for example).

If you're still in school, you're out of luck. For a brief, glorious time, people could nab very low rates by consolidating before they graduated. Congress took away that option in 2006, Kantrowitz said.

(If you just graduated, though, and are still in the six-month grace period before you have to begin repaying your loans, you can lock in the lowest rate of 3.62% for your variable-rate Stafford Loans from your freshman and sophomore years. If you're already in repayment mode, the lowest rate you can get by consolidating that debt is 4.25%.)

The new rates don't apply to already-consolidated debt. You only get one bite at the consolidation apple. You have a few alternatives -- I'll talk about those in a moment -- but your best course may be to pay off the debt you have as quickly as you can.

There are no fees for consolidating federal debt, and you retain many of the important benefits that came with your original federal student loans, such as the ability to defer payments or to choose from a variety of repayment options, including graduated payments (that rise over time) or income-sensitive plans that base payments on what you earn.

In addition, you can get a quarter-point discount for agreeing to automatic debits, which is a smart idea anyway, to make sure you don't miss any payments.

But you won't get a whole percentage point knocked off your rate after three or four years of on-time payments, a perk that used to be widespread when the consolidation market was crowded with competition.

Possible breaks on private loans, too

The new rates don't apply to private student loans. Though rates are dropping, you typically can't lock in the lower rates by consolidating, as you can with federal student loans. But there are other reasons you might consider revamping your private loans.

You might want to consolidate to remove a co-signer from the obligation, Kantrowitz said, although many private loans come with a "co-sign release agreement" that will drop the co-signer from the loan after two to three years of on-time payments.

You also may want to check out consolidating your private loans if your credit scores have improved significantly since you got your loans, Kantrowitz said. A "significant" boost would be 50 points or more on the 300-to-850 FICO scale. The interest-rate break you could win with that kind of improvement, Kantrowitz said, would more than offset the fees involved in consolidating private loans.

Out of luck? 4 options

These days, Kantrowitz said, Federal Direct Consolidation Loans from the Department of Education are pretty much the only game in town unless you're consolidating $100,000 or more in federal debt. The federal loans eligible for consolidation at the department are:

• Direct Loans (subsidized and unsubsidized).

• Stafford Loans (subsidized and unsubsidized).

• Direct PLUS Loans and Federal PLUS Loans.

• Direct Consolidation Loans and Federal Consolidation Loans.

• Guaranteed Student Loans.

• Federal Insured Student Loans.

• Supplemental Loans for Students.

• Auxiliary Loans to Assist Students.

• Federal Perkins Loans.

• National Direct Student Loans.

• National Defense Student Loans.

• Health Education Assistance Loans.

• Health Professions Student Loans.

• Loans for Disadvantaged Students.

• Nursing Student Loans.

Continued: What if you already consolidated?

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