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Time to figure out student loans

Updated: May 3, 2013 12:14PM



You almost need a master's degree to understand student loans.

But by the time you get that degree, you're likely to owe more money than your parents borrowed for their first mortgage. And paying off those student loans could be very costly, unless you understand the changes in rates and new special deals on the repayment process.

If you're a recent college grad with one or more student loans, now is the time to confront the process of repayment. You must set up a plan to start repaying your loans within 180 days of graduation. But if you act sooner, you could save a small fortune in interest.

How rates are set

The auction of U.S. Treasury bills held at the end of May sets the new repayment rate on student loans for the year starting July 1. The repayment rate is the T-bill rate plus a spread of 1.7 percentage points, rounded up to the next 0.8 of a percent. But if you wait too long, that spread jumps to 2.3 percent.

If you're graduating this spring, you'll be very interested in the "repayment rate" that is determined by next Tuesday's Treasury bill auction.

That's because every graduate has a one-time opportunity to consolidate all student loans, and lock in the current rate for the life of the loan.

In recent years, there was a lot of "gaming" of the rate deal. Since the Treasury auction at the end of May determines the new rates that go into effect on July 1, there is a one-month gap period in June, during which you can lock in the current rate if you know it will be lower than next year's rate.

That was definitely the way to go for the past few years. As the Fed raised interest rates regularly, it made sense to get the consolidation process started before July 1, when rates would rise.

Amazingly, though, as I write this column the week before the auction, it looks as if rates will be roughly unchanged from where they were a year ago!

The yield at the end of May 2006 was 4.84 percent. Current trading yields suggest this year's auction will yield about 4.82 percent, the first time in years that rates have stayed flat. But there is still good reason to lock in your repayment process within six months of graduation.

The best reason to consolidate your student loans within six months of graduation is that you'll get a reduction of 0.60 percent (60 basis points) in the interest rate. If you wait, the rate will be higher.

Many consolidation lenders will shave another 25 basis points (0.25 percent) off your loan rate if you agree to an automatic deduction of your monthly payment from your checking account.

Beyond that, there are some other intriguing deals. You can compare them at www.SimpleTuition.com. Now that the rules have changed to allow you to consolidate with any lender, the competition is heating up.

Traditionally, lenders would give you another rate break if you pay on time for three or four years. Now, many offer rate discounts starting after only one year of on-time payments. Others might deduct $500 to $1,000 from the amount of your loan as a reward for a good payment history.

Many people choose to consolidate because doing so allows you to extend the 10-year standard loan term.

Why NOT to consolidate

That might be the worst reason to consolidate. Sure, a longer term means lower monthly payments, but it also means that over the life of the loan, you'll pay a lot more in interest. How much? Use the calculators at SimpleTuition.com or FinAid.com to see.

Student loans are debt that makes sense, because the result should be more dollars in your paycheck over your lifetime. Don't make the mistake of burdening yourself with unnecessarily high rates, or huge interest bills -- all of which offset the benefits of your education. And that's The Savage Truth!

Terry Savage is a registered investment adviser. Check out Terry's answers to reader questions at suntimes.com, and click on Business.



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