Reading Your Student Loan's Fine Print

The amount Americans borrow for college through federal student loan programs has nearly tripled over the past decade. With annual student loan borrowing levels surpassing $35 billion dollars, any provision that reduces the cost of repaying college debt would appear to offer families welcome financial relief. Many student financial aid experts, however, warn that a Clinton administration initiative that promises reduced student loan interest rates for some college graduates could actually increase total borrowing costs for hundreds of thousands of others.

Student aid experts caution that many student loan borrowers who accept the administration's offer could unwittingly end up locking in the highest-possible student loan interest rates, foregoing potentially lower interest rates in the future, and passing up more valuable interest-saving benefits offered by private lenders.

"We are advising student loan borrowers to read the fine print and proceed with caution," said Shelly Repp, general counsel for the National Council of Higher Education Loan Programs.

On Aug. 10, President Clinton announced that student loan borrowers who consolidate their loans in the federal government's direct loan program would receive an 0.8 percentage-point interest rate reduction. Borrowers who make their first 12 consolidation loan payments within six days of the due date retain the discount for the remainder of the repayment period.

Critics of the plan note that the federal government's own estimates indicate some 77 percent of these student loan borrowers will fail to make their first 12 payments on time and lose the discount. Because current student loan interest rates are at or near the maximum levels set by law, these borrowers will end up locking in the highest-possible student loan interest rates for the repayment period on their fixed-rate consolidation loan, a term of up to 30 years. Based on the administration's estimates, more than 300,000 borrowers with college loans could get stuck with higher interest rates.

More troubling, these borrowers will likely forego lower student loan interest rates in the future. The Congressional Budget Office (CBO) estimates that interest rates on variable-rate student loans will fall from the current rate of 8.19 percent to 7.2 percent by 2005. Borrowers who lock in the current high student loan rates through a fixed-rate consolidation loan will miss the opportunity to enjoy these lower rates in the future. According to one analysis, a borrower who consolidates $25,000 and loses the 0.8-percentage-point discount would forego nearly $200 in savings if the lower interest rates forecast by CBO come to pass. The additional interest costs will be much larger for those borrowers who elect an extended repayment term, which the majority of consolidation borrowers choose.

In addition, student aid experts advise borrowers to check if they qualify for potentially more valuable borrower benefit plans offered by private lenders. Many lenders offer interest rate reduction options that typically provide a 2-percentage-point reduction in the interest rate for borrowers who make their first 36 to 48 monthly payments on time. A graduate who qualifies for a lender benefit program on $25,000 in student loans would save $345 more than a borrower who qualifies for the direct consolidation loan discount and repays an equal amount over the same 10-year period.

"Many borrowers may find that consolidating their loans in the government's program is not in their best interest," Repp said.

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