Public Service Announcement: Student Loan Consolidation

In the last few years I have learned of some people who have needlessly cost themselves a lot of money for lack of information; I am writing this post hoping to help someone from making the same mistake. I have no affiliation with the loan consolidation services mentioned below, I just want to offer what I have learned while consolidating my own loans. This is not professional advice and there are no guarantees that all of the information is accurate. You may want to consult with a financial aid counselor to assess your unique circumstances. In other words, all the usual lawyerly caveats apply.

For those just beginning to come to terms with the fact that the government loans used to finance their education will have to be paid back, a short primer is in order. Some loans are eligible for consolidation and others are not. The loans most popular with graduate students, Federal Direct and Stafford loans are eligible and, as of July 2001, Perkins loans are also eligible as long as you have one outstanding Direct loan to consolidate with it. 

The primary advantages of consolidation are: 1) it allows you to fix the rate of your loan (most government loans are floating rate loans with an interest rate cap), 2) at the time of consolidation it is usually possible to choose from a variety of repayment plans which can reduce monthly payments and 3) lenders offer incentives for consolidating loans with them.  A reputable consolidation service will not charge fees for consolidation.

Potential disadvantages of consolidation are: 1) you may lose the grace period deferring repayment until after graduation and 2) the loss of eligibility for loan forgiveness programs offered by (a few private) schools.

When you consolidate you will be assigned a weighted average, rounded to the nearest 1/8th of a percentage point, of the interest rates for the loans consolidated. If you have a Direct loan with a floating rate of 2.77 and a Stafford loan with a rate of 3.5, for example, your weighted average will be determined by a formula which takes into account the differences in the interest rates and the amounts of the loans. If you are truly interested in the formula, you can email me and I’ll send it to you.

If you took out certain federal loans while attending a higher educational institution in Utah, even a private one such as BYU, and then subsequently took out additional qualifying loans while attending a higher educational institution somewhere else, you are eligible to consolidate all of your loans through the Utah Higher Educational Assistance Authority (www.uheaa.org). UHEAA offers by far the best terms for student loan consolidation that I am aware of. For example, most institutions that offer student loan consolidation services will offer a deduction in the interest rate to those who allow monthly direct debiting of their account. Previously the interest discount was around 1%, but over the last few years as interest rates fell most institutions lowered the discount. The federal government, for example, used to offer a 1.25% to those who consolidated through them, but now offers 0.25% (http://www.loanconsolidation.ed.gov/) which is a fairly typical discount. UHEAA, however, for reasons unknown to me, continues to offer 1.25%. This is the biggest advantage you can gain from using UHEAA–more generally however, if you work the system a little you can get yourself up to another 1.6% in interest rate deductions. If you played the game perfectly, you could pay as little as 1/20th of a percent on your loans. An average effort will still save you almost 2%–even if you are ineligible to consolidate through UHEAA.

Most of the loans I took out while I was in law school were Direct loans. The interest rate of Direct loans and Stafford loans is pegged to the 91-day T-bill plus a premium that varies with whether a student is (a) in school, grace or deferment (the "in school rate") or (b) repayment or forbearance (the "out of school rate"). This rate is set each year on July 1st, so for any given year it only matters what the 91-day T-bill discount rate was on the preceding July 1st. On July 1, 2004 the 91-day T-bill rate was 1.07% and the add-on premium for (a) above is 1.7% and for (b) above is 2.3%. In other words, the "in school rate" is 2.77% and the "out of school rate" is 3.37%. If you consolidate while in school you can lock in the lower rate permanently. The federal government is aware of this loophole and has blessed it in the Federal Register, Volume 64, Number 210, dated November 1, 1999. 

It is worth noting that the 91-day T-bill rate will likely be higher next July than it was in 2004 so locking in rates now might be a good idea. (If you are nowhere near graduation and have no income to service loan payments you should check to see if locking in the rate will cause you to go into repayment.) 

As mentioned earlier, many companies give you incentives to consolidate through them. Most common is an interest rate deduction (typically 1%) for making a predetermined number of payments on time and the already-mentioned interest rate deduction for setting up direct debit payments from your bank account (typically 0.25%, but 1.25% through UHEAA). Many private companies require that you continue to make all of your payments on time in order to keep your interest rate deduction and a payment that is even a day late can cost you the deduction for the remainder of the term of your loan.

THE PERFECT GAME: If a current student had only unconsolidated Direct or Stafford loans and chose to consolidate all of her debt through UHEAA while in school (so as to take advantage of the lower add-on premium afforded current students), set up payments through direct debiting of her account and made her first 48 payments on time, she would lock in a rate of 0.05%. 2.77% – 1.25% – 1.0% = 0.05%! If you were paying on $100,000 over 30 years at that rate, you would average only $2.09 a month in interest (I think I did the math right)! If you consolidated through the federal government the best rate you could make under that scenario would be 1.05% (still incredibly low!). The difference in interest between the two rates over 30 years would be $15,865.20. Moral of the story, use UHEAA if you can but in any case don’t put off thinking about this since rates are likely going up.

Comments

  1. There has been some discussion of switching from a fixed rate on consolidated loans to a variable rate. This should not impact those who have already consolidated, but is another reason to lock your rate in now.

  2. Plus be sure to pay your tithing when you take out your student loans!

  3. Would you pay tithing on your student loans? Do you pay tithing on your Mortgage or an auto loan? Hope this isn’t a threadjack.

  4. Jay,

    part of the principle of consecrating is devoting all you have to the Lord. Thus, under the temporal law of tithing, a tenth of my student loan debt belongs to God. I provide the bishop with an invoice at tithing settlement.

  5. Everything that you said makes sense, but UHEAA’s website doesn’t make it a point to tell people that they can actually SAVE money by consolidating with them. It does briefly mention that you can get “borrower incentives” and reduce your rate on your UHEAA loans by paying on time and setting up the automatic withdrawl. I just wonder why they’re not ENCOURAGING borrowers to consolidate in order to save money.

    “The advantage to consolidating is to simplify repayment by allowing you to make one payment on all your consolidated loans, but doing so may end up costing you money. Making your payments under the standard plan will save you money over any consolidation plan.”

    “Repayment will be simpler with a consolidation loan since you can replace multiple payments with one monthly payment. However, consolidation can cost you more money over the life of your loan.”

  6. Steve,
    That’s funny stuff. Boy, if we devote all our debt to the Lord, the Church owes me big.

  7. Rusty, you obviously haven’t read the Handbook on this point, but it’s there, in fine print: “Bishops gotta pay if people bring in, like, their debt stuff.”

    Now march on in there and get your piece of the pie!

  8. While we’re on the subject, some lenders will lower the interest rate if you set up automatic payments. This makes it a no-brainer to qualify for even lower rates under some “pay on time” programs.

  9. Doh… Should have taken out more student loan debt in college, I could have taken advantage of that extra leverage (just think what I could have done with that extra 10%)

    On a more serious note, consolidation is not necessarily the best thing for everyone. Especially if you and your spouse have student loans. Most student loans, unlike mortgages or auto loans, only make the individual liable for repayment. Thus if I die, the x dollars I owe for too much school are not required to be repaid by my wife (of course it would come out of my estate, but since I basically have no assets now it is free “life insurance”). If my wife and I consolidated together, we would both be on the hook for each other’s loans. This may only apply to a few of us, but it is something worth considering. Of course you could consolidate individually.

  10. Consolidation may also _remove_ people from liability. For example, if you have a co-signer on a loan, you could consoldate individually and that co-signer would no longer be liable.

    For that matter, you could arguably consolidate your way all the way out of liability — get a co-signer to sign the loan, then have your co-signer consolidate individually (I think that’s possible), and viola, no debt for you! (You have to find a pretty generous co-signer for this to work).

  11. Jay, I don’t know why you’re joking about taking out more student loans. I don’t need half of mine, but we took as much as we can out to have money for a down payment on our apartment here in Brooklyn. Without it we’d still be renting and giving our money to someone else. There are much better ways to invest the money they give you than to not take it.

  12. Rusty has presented the benefits of leverage without disclosing the dangers. Taking out student loans to buy an apartment isn’t necessarily a bad strategy. In fact, many people take out 80/20 loans to buy a house, which is somewhat similar. However, if you are just a student and don’t plan on living in the area after graduation, many people will tell you that the real-estate market shock risk is too great for a short-term real estate purchaser. The downside is that, absent a significant appreciation in the property in the near term (which people have come to expect in places like NY and Boston), you’re still giving your money to someone else — the bank — and you assume the market risk with no equity buffer. In addition, even in a rising market, the first few years of home payments consist almost exclusively of interest and you bear loan origination costs at the front end as buyer and broker commissions as seller. Interest is accruing on your “down payment” to boot.

  13. Marko accurately describes the dangers, but if you do know a thing or two about real estate, it can be lucrative if you’re careful.

    I think that it’s important to view debt as simply another form of investment. In other words, repaying a loan on which you paid 5% is the same (excluding taxes) as gaining 5% on an investment of the same amount. If you’re sticking savings in your 2% ING account instead of paying off your student loans, in the name of saving up for an investment, you might want to think twice.

    Of course, indebtedness has a whole moral quality to it as well, particularly consumer debt. The Brethren have addressed this topic at length.

  14. My joke was in response to the tithing leverage; ie if we give 10% of our increase to the lord we should give 10% of our negative increase (Debt) to the lord as well.

    I understand the idea of using student loans to by a house. a lot of my friends did it in Law School/undergrad. Many are sorry now, because of a flat/depreciating Utah Real Estate Market (but that is another matter). I think Marko addressed some of the risks very well. Also renting isn’t a horrible thing. It is not “throwing your money away”. Rusty, you said you didn’t want to give your money to someone else? What is the interest you pay?

    Also depending on the market/situation renting can be much better financially. If I had purchased a home in provo, there would have been no way for me to attend internships in DC/Portland/Etc or go live with the parents for the summer while Dad had cancer. Also there are transactions costs that can be killer, especially in flat markets.

    Also rent can be a lot cheaper, even in a booming real estate market. I am in Vegas, my mortgage is approx 1.5x that of my rental payment was for only a slightly bigger house. Personal reasons aside, it could be very adventageous to rent and invest the difference.

    But getting back to the thread, I have often wonder about the morality of taking more student loans than you need to get through school. By this I mean purchase a home, start a business, buy a car etc. I don’t think there are any legal obligations on the use of the money, but is it moral, is it ethical to do so?

    My arguement is that the intent of subsidized loan programs is that the government/taxpayers pay to have lower interest rates available to pay for school. The intent is to allow more people the opportunity to educate themselves. By taking the additional money you deprive others of that opportunity. even assuming that the amount of student loans is unlimited, you are passing on additional cost to the taxpayer.

    The thing I found interesting is that many of my class mates who took the max in student loans were also staunch conservative/anti government spending. This is my personal non substantiated observation of course, and do not have any evidence to point either direction.

    So, political rhetoric aside, is it ethical and or moral for a latter day saint to take more student loan than is needed?

    Sorry about the rambling…

  15. Jay raises some interesting questions. First, is it the case that there are no restrictions on the use of student loan money? I’m pretty sure the government has decided not to monitor the use of the funds, and instead has decided it to be easier to regulate through the use of need calculations and an overall cap. But this may only be the result of the government determining that the administrative costs of monitoring the use of student loan monies are too high when compared with the costs of the alternative (need calculations + possibly increased abuse). It may in fact be the case that the borrower agrees to use the money only for certain approved purchases, and taking the money and putting in google stock would violate the terms of the loan.

    Second, assuming there are no usage restrictions, I don’t think it is necessarily immoral to take advantage of a government subsidized program because your intent is not aligned with the government’s. Take, for example, mortgage interest deductions. The government provides this deduction ostensibly to incentive home ownership because of the positive externalities associated with home ownership in general. If I take out a home equity loan to pay off student loan debt (or consumer debt), should I then voluntarily exclude the interest paid on the home equity line in preparing my tax returns and forego the tax break? The result seems the same to me — having the government subsidize my behavior despite unaligned interests.

  16. One problem is that if have already consolidated (which I did at a record low 6% upon graduation) and then the interest prices dip further, you are not allowed to re-consolidate at the lower rate. Meaning that educational loans are the only loans not available for refinance. I think there is a bill that has been introduced in Congress addressing this, but I don’t know the details. Maybe all of us socially powerful lawyer types should raise our voices in protest…

  17. Additional tip:

    I confirmed that the discount for making 48 on time payments can be _accelerated_; i.e. you can make 48 monthly payments all at once, or 1 monthly payment a week for 1 year, etc. and you will then get the interest rate reduction. Caveats:
    1. You have to explicitly & expressly notify UHEAA that you are doing this;
    2. If you have other debts (likely), it makes much more sense to pay off other debts with higher rates first rather than forking out 48 payments just to get a small reduction.

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