Student loan scandal: Effects on consolidation

NEW YORK (CNNMoney.com) -- It's a good thing you got that college education. You can put it to good use navigating the complex maze that is the student loan industry as you consider whether to consolidate your federal student loans.

For those who have never done it, it's a question that comes up every year in anticipation of the rate change on July 1 of the variable federal student loans.

But this year, there's a twist. News of student lenders offering perks and kickbacks to colleges and alumni associations to include them on preferred lender lists have, understandably, made consumers wary.

But that actually may be one good thing to come out of the scandal. The advice about deciding whether and with whom to consolidate hasn't changed. It's just become even more relevant.

"The current scandal reinforces the need to be a savvy consumer and examine carefully any offer you receive no matter where it comes from," said Lauren Asher, associate director of Project Student Debt and the Institute for College Access and Success.

Indeed, said Mark Kantrowitz, publisher of FinAid.org, "even when a school's preferred lender list is unbiased, you still have to identify which loans are best for you."

The question of whether to consolidate your federal loans depends on the type of loans you have, their rate (variable or fixed) and your goal: Do you want to reduce the interest you pay long-term? Lower your monthly payment? Pay just one bill instead of several? Get better discounts?

It also depends on whether you've already consolidated the loans in question before. By law, you may not consolidate the same loans twice.

Here's what to consider if you have:

If your Stafford loans were issued before July 1, 2006 they are variable-rate loans.

What determines the change in the variable rate every July is the yield on the 3-month Treasury bill during the last T-bill auction in May. Currently, the yield is very close to where it was a year ago. So if the 3-month yield doesn't move much between now and the end of the month, payments on your Stafford loans are not likely to go up much, if at all, after July 1.

So there's little reason to consolidate if your sole goal is to lock in a lower rate this year.

But there is one exception: if you're still in your so-called grace period, defined as up to six months after your graduation. That's because you still are enjoying the "in-school" rate, which is about 0.6 percentage points less than it will be when your grace period ends and you go into repayment. Consolidating before your grace period ends lets you to lock in that lower rate. Technically, you may lose out on some of your grace period because you will need to begin repayment within 60 days of consolidating. But if you apply for consolidation before July 1, a lot of lenders can set it up so that the clock on that 60 days doesn't start until close to the last two months of your grace period, Kantrowitz said.

There's also little reason to consolidate if you want to lock in a lower rate and you got your Stafford loan after July 1, 2006. That's because those loans are fixed rate loans at 6.8 percent and won't change.

Whether you have variable or fixed rate Staffords, however, you might consider consolidating if you want to reduce your monthly payments. You can do so by combining your loans into one loan and extending the repayment term. But by doing so you greatly increase the amount of interest you'll pay. By changing your repayment term from 10 years to 20, you'll cut your monthly payment by a third, but you'll double the amount of interest you pay long-term, Kantrowitz said.

A 30-year term is even more expensive. Say you have $20,000 in fixed-rate Stafford loans. Asher notes that you'll pay $7,619 in interest on them over 10 years. But if you consolidate and extend the repayment term to 30 years, you'll lower your monthly payment by $100 but you'll end up paying $26,935 in interest.

Besides rates and monthly payments, weigh discount incentives when considering consolidation. Many lenders offer breaks if, say, you direct debit your payments or pay on-time for 36 consecutive months. Compare not only consolidation discounts offered by different lenders, compare them to the discounts you're currently enjoying. Sometimes, Kantrowitz said, "discounts for consolidated loans are inferior to those on unconsolidated loans."

(Here's a good table for comparing specific discounts at FinAid.org. For a more general look at which discounts are more valuable than others, see this table from the Project on Student Debt.)

Once you have loan consolidation offers in hand, you can see which offers the better deal by using FinAid.org's loan consolidation calculator.

These are fixed-rate federal loans at 5 percent. Student loan experts caution against consolidating them because doing so makes you ineligible for loan forgiveness programs. (Here's more information on the types of loan forgiveness programs available.)

Private student loans are much costlier loans than those guaranteed by the federal government and borrowers don't enjoy the same protections as with federal student loans.

If you're among the minority of borrowers who have taken out private loans, and lenders send you offers to refinance your private loans, Asher's best advice: "Be even more careful (than you'd be with federal loan consolidation offers)." That's in part because the rates on these loans are based on your credit and can be as volatile as credit card rates.

Here are good questions to ask before taking out or refinancing private student loans.

And for both federal and private student-loan related questions, Kantrowitz's FinAid.org student loan page is an excellent resource.