Students urged to consolidate loans before rate rise

With more interest-rate hikes looming, the time might be ripe for advising clients to consider consolidating the various federal loans they take to pay for higher education.

Indeed, companies that specialize in helping students and parents pay off such debts are urging folks to consolidate the federally guaranteed variable rate loans, known as Stafford loans to students and Plus loans for their parents.

The idea is to lock into a fixed rate before the rates of the variable loans are reset as they are every July 1.

“Presuming that we’re in an increasing-interest-rate environment, and will be for some time, converting to a fixed takes that risk away,” says Michael Blattman, vice president of sales and marketing at Collegiate Funding Services LLP.

The two-year-old student-loan consolidation service is based in Fredericksburg, Va., and made 25,000 loans totaling $450 million last year.

To bolster its case, Mr. Blattman’s company recently commissioned a survey of 22 personal-finance and credit advisers at three of the top five U.S. securities firms and seven of the 20 largest commercial banks.

taking advantage

The survey, conducted by Penn Schoen & Berland Associates Inc., found that 32% of these experts considered it “very important,” and another 55% “somewhat important,” for graduates or parents who are “saddled with high student loan debt” to take advantage of current low interest rates, since those rates seem to be on the rise.

“Obviously, if rates crash, then fixed is not the way to go,” agrees Mr. Blattman, “but that doesn’t seem to be happening any time soon.”

Adds Gary Frazier, Collegiate Funding CEO, “People tend to be less strategic about managing their student loan debt than they are about things like credit cards, mortgages and car payments.”

Naturally, there are caveats, such as those cited by Denise Rossitto, spokeswoman for Sallie Mae, a private enterprise created in 1972 by the federal government as the Student Loan Marketing Association. The giant loan servicer handles almost 40% of the $180 billion U.S. student-loan market.

Ms. Rossitto doesn’t see what the rush is all about, particularly in light of the congressionally mandated caps on federal student loans. She adds there are other ways to lower monthly payments.

“I’m surprised they’re using an interest-rate scare,” says Ms. Rossitto. “Consolidation is for the person who’s heavily indebted, but it’s not to get a lower interest rate. There’s no one-size-fits-all solution for that.”

Ms. Rossitto notes that consolidation can actually raise a borrower’s rate, and that borrowers can lower their monthly payments by stretching payments, for example, over 20 years instead of the usual 10.

alternatives

Consolidation as a strategy should really be employed for folks such as young doctors, who might incur $70,000 to $120,000 in debt, but can’t afford to pay it off fast enough, says Philip C. Johnson, a certified financial planner in Clifton Park, N.Y.

“The basic principle should be to pay back non-deductible debt as quickly as you can. The alternatives are just if that first choice is not possible,” he says.

James F. Bell, an Oakland, Calif.-based financial planner for retirement and education-fund planning, offers another caution.

“This is actually a pretty good time to have debt,” he contends. “People need to look at what their investment experience is vs. diverting money to pay down debt. The debt might be at a much lower rate than what they’re earning in stock mutual funds, for example.”

rates to rise?

The annually adjusted rate for a Stafford student loan is tied to the last 91-day Treasury-bill auction held in May, that of the Plus loan to the final May 52-week T-bill price.

Currently, Stafford loans in their repayment phase (they’re lower while a student is still in school) charge 6.92% in interest, reflecting last May’s 91-day T-bill rate of 4.62% plus 2.3%.

Plus loans, under a similar formula, currently charge 8.13%. By law, Stafford loan interest rates are limited to 8.25%; Plus loans are capped at 9%.

If the Federal Open Market Committee indeed raises short-term interest rates at the next opportunity, March 21, that will mark five rate hikes since last June. And many bond traders predict two more by July.

T-bills don’t necessarily move in lock step with the Fed’s short-term interest rate, of course.

Yet Collegiate Funding says it has found a reliable correlation between T-bill rates and Fed rate hikes, and predicts that on July 1 Stafford loans could easily increase to 7.85% while Plus loans could hit their 9% limit.

Mr. Blattman calculates that if current T-bill rates had been applied to federal student loans as of Feb. 25, Stafford loans, for example, would now have risen by 0.93%.

So why aren’t Sallie Mae, the Department of Education’s Federal Consolidation Loan Program and other educational lenders pushing consolidation?

“Organizations do not want to convert a variable-rate asset into a fixed-rate asset because they’re cannibalizing their earnings,” says Mr. Blattman.

Mr. Blattman’s company, in contrast, tries to induce borrowers to switch horses by dangling monthly payment reductions of up to 43% and a 1% interest-rate cut after five years of on-time payments.