Updated: May 3, 2013 12:14PM
Originally published: August 7, 2001
Here’s great news for student loan borrowers: Interest rates on federal student loans will drop to their lowest level ever on July 1! That could translate into a savings of $1,300 in total interest payments on a 10-year, $10,000 student loan, if rates stay this low. With more than $150 billion in federal student loans outstanding, that adds up to a lot of money saved for a generation that’s just starting to earn money.
It’s automatic. The new lower rate will be applied to your outstanding loans, based on when they were taken out. For example, the repayment rates on federal Stafford loans disbursed on or after July 1, 1998, will drop from 8.19 percent to 5.99 percent. Those rates are determined by the 91-day Treasury bill rate, set at the last weekly auction in May. Since the Fed has been busy cutting rates all year, the benefit will now be felt in the once-a-year adjustment for student loan interest.
Because loans carry different starting rates, depending on when you took them out, and different caps on how high the interest could go in previous years, not all loan rates will drop to the same level. While interest on the most recent Stafford loans drops to 5.99 percent, the repayment rate on Stafford loans taken out between July 1, 1995 and June 30, 1998, will drop only to 6.79 percent from the current 8.25 percent. Rates on PLUS loans taken out by parents since July 1, 1998, will also drop sharply--from 8.99 percent to 6.79 percent.
Use EFT to lower rates even further
You can lower your rates even further with most lenders if you agree to make your payments through an automatic debit of your checking account. That typically shaves another one-quarter of one percentage point off your loan interest. And many lenders will drop your interest rate by one to two full percentage points if you make three to four years of on-time loan payments.
Some guarantors, such as USAfunds, waive the 1 percent upfront guarantee fee that may be charged to student loan borrowers when the loan is taken out.
And here’s another benefit for student loan borrowers. In 2001, up to $2,500 of education-loan interest on the first 60 months of repayments can be deducted from your income tax return, subject to income limits. Starting in 2002, under the new tax law, almost all borrowers will be able to deduct all the interest they pay over the entire life of the loan.
But those lower rates and tax deductions don’t mean you should stretch out repayments forever. You should make it your goal to repay student loans as soon as possible, so you can start saving and investing for other goals. Now that you’ll be making a lower monthly payment, you might want to make additional principal payments and get out from under that loan even faster. There are no prepayment penalties for student loans.
Beware of consolidating too soon
One other strategy might make sense, but you won’t be able to assess it until next May. Once you graduate, you’re allowed to consolidate your student loans and lock in the current rate for the life of the loan. The consolidated loan rate is based on the current blended rate of all your loans, rounded up to the next one-eighth of a percent. But you can consolidate only once. And if rates subsequently move even lower, you’ll regret that you did the consolidation now. So the solution is to wait until next May 2002--just before the rates are set to change again. By then, you’ll have a clearer picture of the future.
If rates have dropped even further, you’ll want to consolidate after rates change in July 2002. But if rates trend higher throughout the year, you’ll want to start the lock-in process at this year’s rates next May to beat the July 1, 2002, adjustment.
The bottom line on student loans
If you’d like to see how the lower rates affect your payments, go online to www.usafunds.org and use their calculators to see what your monthly payments will be. USAFunds is one of the largest student loan guarantors, and its Web site is full of information on student loans and the process of repayment. You can also check in at www.wiredscholar.com, www.salliemae.com, or www.ed.gov for more information on the repayment and consolidation process.
Your student loan was a worthwhile form of debt, because it financed a growing asset--your mind. Now unburden both your wallet and your mind by paying down those loans in the most expedient way possible.
That’s the best use of your education . . . and that’s The Savage Truth.
Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McIDonald’s Corp. and Pennzoil-Quaker State Co. Send questions via e-mail at firstname.lastname@example.org. Her third book, The Savage Truth on Money, recently was published by John Wiley & Sons Inc.