5 Things To Do

Things You Must Do with Your Student Loan Debt

On July 1, the interest rate on federal loans will increase significantly. Act before then to ensure you're not paying more for your education than necessary

By Jeff Wanic and Dan Thibeault

For many MBA students, there's only one thing worse than juggling their hefty course loads: figuring out how to pay for business school once it's over. MBA students routinely sign their financial aid forms without understanding the choices they have to keep their future loan payments as low as possible. As a result, they risk spending thousands of dollars more on their education than necessary.

Fortunately, students have a new incentive to make money-saving decisions about their educational loans. In February, Congress passed a bill eliminating federal loan consolidation for current students and raising the rate on all new Stafford loans from 4.7 percent to 6.8 percent. The law goes into effect on July 1, which leaves you enough time to act.

For starters, now is a good time to shop for a new lender. Thanks to widespread availability of information, the loan-consolidation marketplace has grown increasingly competitive, providing a range of opportunities to lower the cost of debt on your federal and private loans. Graduate Leverage is an ideal place to evaluate your options, at no cost to you. We've put together two lists of five tactics—one for students graduating this May, and one for those graduating later—that will help you lock in the lowest possible lending rate. Assuming you'll have anywhere near the average MBA graduate debt of about $65,000 (for students who take out federal and private loans) or $37,000 (for those who have only federal loans), you'll stand to save a lot of money if you act before July 1.

For 2006 graduates

1. Consolidate your federal loans

   As of July 1, the Stafford loan rate of 4.7% will be history. Current rates would translate into a student loan rate above 6%. Be sure to consolidate your federally guaranteed loans before the rate change goes into effect to ensure you lock in the lower rate.

   Consider carefully which lender will offer you the best deal. Even with federally guaranteed loans, lenders compete for your business by offering a combination of rate incentives and borrower benefits, both of which can substantially lower your cost of borrowing.

   As with any business agreement, study the details. Many lenders have preconditions, which they hide in the fine print, that limit the value of their incentives and benefits.

2. Consolidate your private loans

   Although your private loans are not eligible for federal consolidation, you can still reduce your monthly payments and improve your financial position by consolidating your private loans.

   Doing so before graduation enables you to take advantage of the higher credit score you may have developed since starting business school. Students who pay their bills on time and generally maintain a positive credit record establish an increasingly stable credit history. A better credit record generally translates into lower borrowing rates.

   However, lenders do not automatically reduce their borrowers' interest rates simply because the borrowers' credit ratings have improved. The only way to secure a revised lending rate and lower monthly payment is to consolidate your existing loans. Graduate Leverage can help evaluate your private loan options by formulating a recommendation based on your current debt portfolio.

3. Choose a cost-efficient supplemental loan

   If you don't expect to have an income until well after graduation, you'll need to keep yourself financially afloat in the meantime.

   Whatever you do, avoid running a large balance on your credit cards. Credit accounts tend to charge exorbitant rates and offer inflexible terms. And be careful if you receive offers for credit cards with low or 0 percent interest on balance transfers. Many people use such low rates as an excuse to increase their borrowing, which they still have to pay back eventually. Opening too many credit card accounts also risks harming your credit history, which will increase your future cost of borrowing.

   A far better option than credit cards is to take out a private loan. Most educational lenders offer such loans with a limit of between $10,000 and $15,000. When selecting a lender, be sure to consider the loan rate, term, fees, and grace period.

   Based on an analysis of the current offerings of 10 lenders, we've listed the most attractive terms available below. If you need a supplemental loan, this should give you a benchmark for deciding whether a lender is offering a reasonable deal:

   Rate: LIBOR + 2.7% (7.50% at today's rate) or Prime + 0.5% (8.00% at today's rate)
   Term: 20 years with no prepayment penalty
   Fees: No origination or repayment fees
   Grace period: Nine months

4. Extend your grace period and pay off your credit card debt

   If you have federal student loans and a high-interest credit card debt of more than $500, a good way to focus on reducing your credit card debt is by extending the grace period on your federal loans. All federal student loans include a six-month grace period after graduation before repayment begins. In addition, federal loans are eligible for so-called financial hardship forbearance, which suspends payments for 12 months. Despite the name, financial hardship forbearance is available to you even if you're earning a salary. Forbearance has no negative impact on your credit rating, and lenders rarely deny requests for it.

   Use your grace period or forbearance to pay off your credit card debt as much as you can. Typically, credit card debt is at least 7 percent higher than your student loan rates. Therefore, you'll save money in the long run by making large payments on your credit cards before you pay off your student loans.

5. Don't pay off your student loans early

   At today's interest rates, your federal student loans are probably the least expensive debt you'll ever incur. These rates are so low—well below 5 percent—that it's actually wise not to pay them off before they're due. This may seem counterintuitive, but it makes great fiscal sense when you take inflation and the time-value of money into account.

   Though the interest rate is a fixed value, the real interest rate to which your loans are subject is a bit more complicated. Because it adjusts for inflation, a real interest rate is a more accurate measure of a debt's cost. Consider this hypothetical case: A student graduated last year with a rate of 2.875 percent on his consolidated loans. During the past few years, the inflation rate has hovered at about 3 percent. By subtracting the inflation rate from the interest rate, we discover that the current real interest rate on this student's loans is negative 0.125 percent. In other words, you're making money by borrowing money.

   So while it may be true that federal student loans accrue interest, it's also true that they can accrue interest at a negative rate when adjusted for inflation. As odd as it may seem, your low-interest loans are working for you. Any prepayments made would actually increase your real cost of borrowing.

For 2007 graduates

1. Take advantage of in-school consolidation

   Continuing students need to complete an in-school consolidation prior to the July 1 rate change in order to lock in the current low rate of 4.7 percent. If you wait until after that date to consolidate, all your loans will be reset to the new rate of more than 6 percent. This would cost you more than $5,000 in missed savings if you're an average 1st year and nearly $11,000 if you're a typical 2nd year.

2. Determine whether to take a private or PLUS loan

   Along with the interest rate changes, the new legislation will introduce an additional federal loan for graduate students called a PLUS loan. Unlike federal Stafford loans, PLUS loans will have no borrowing limit. Furthermore, PLUS loans carry a fixed rate, which based on a sampling of business students’ debt, is lower than the private loan rate for more than 80% of the population. Consequently, you will want to consider a PLUS loan in lieu of a private loan when looking to pay for expenses not covered by Stafford loans. You should also be aware that given the introductory nature of the PLUS loan program, some financial aid officers may not be familiar with the benefits it presents. If your aid package does not include material on PLUS loan options you will need to contact a student lender directly.

   Here are some considerations to weigh when deciding which option is best for you:

   When to choose a PLUS. All students receive the same interest rates on PLUS loans. Because of lender incentives, the actual rate usually falls between 7.25 percent and 8.5 percent. In contrast, private loans offer rates that are tied to your credit rating. When deciding between PLUS loans and private loans, be sure to compare the best possible private loan rate against the current PLUS rate. If, after reading the fine print, you determine that the rate for the private loan exceeds the PLUS rate, then you should definitely choose the PLUS loan. If you would like assistance in completing this, contact Graduate Leverage for a personalized analysis.

   When not to choose a Private (maybe). If the private loan rate is lower than the PLUS rate, you may want to go with the private loan. We say "may" because PLUS loans are federal loans and therefore can only be acquired by current students. Private loans, on the other hand, can be taken out after graduation via private loan consolidation. Thus, if you've taken a PLUS loan instead of a private loan and interest rates drop significantly after graduation, you still have the option of switching to a private loan through consolidation. If, however, you choose the private loan over the PLUS loan in order to get a marginally better rate, only to discover after graduation that rates have increased significantly, you won't be eligible to switch to a lower-interest PLUS loan. As a result, if the rate you could obtain on both loans was the same (say 7.5%) then the decision depends on what happens to interest rates in the future. If you take a private loan and rates increase, your rate will be above 7.5% and therefore you would be worse off. On the other hand if you took a PLUS loan and interest rates decreased, your loan would still be at 7.5% (while the private loan rate will have dropped) and as a result you would be worse off. The final catch again is that PLUS loans can be converted into private loans but private cannot be converted into PLUS. So if you’re still confused here’s a rule of thumb for you: if your private loan rate is not more than 0.5% less than the PLUS rate, take a PLUS loan. Again, completing this analysis can be overwhelming and time consuming. Please feel free to contact Graduate Leverage for a PLUS vs. Private loan evaluation at no cost to you.

3. Choose the Stafford lender that offers the best value

   The federal government regulates all federal student lending, setting both the maximum rates and the fees that lenders are allowed to charge. However, lenders frequently offer rate reductions and discounted origination fees as a way to entice students to borrow from them.

   Many students miss out on this easy path to saving money on their loans. When comparing lenders, be sure to ask about the origination fees and rate incentives they offer on their Stafford loans. Some lenders offer a 0% origination fee, which offers the most immediate savings for borrowers. And, as we counseled 2006 graduates in suggestion 1 above, be sure to read all the fine print when comparing lenders.

4. Choose the best rate when choosing a private lender

   As obvious as it may seem, many students fail to secure loans at the lowest available rate. As a result, students frequently end up paying far more than they should for their education. Most lenders are reluctant to provide full disclosure on their rates, opting instead to offer a rate range to prospective borrowers. Only after the loan has been secured do they provide students with their specific rates.

   Don't settle: Be sure to find out precisely what the rate will be on the money you're about to borrow. You wouldn't order a restaurant meal if the waiter told you that it costs "somewhere between $5 and $50," would you? Why then settle for fuzziness from your lender when you're spending thousands of times what you would on dinner?

5. Don't use private loans to pay off interest on federal loans

   A common mistake students make is to begin making payments on their federal loans while continuing to take out private loans. Because private loans have significantly higher rates than federal loans, borrow only what you need in order to cover your living expenses.

   While some may argue that paying off interest on federal loans while still in school can help lower your overall costs, this is not the case for all borrowers. The only time you should consider such borrowing is if you have excess disposable funds. However, if you do find yourself in the enviable position of having disposable income, you should use this to pay down all remaining credit card, private loan, or federal loan balances.

For more information, please visit www.graduateleverage.com or call 888-350-8488.