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No rush to consolidate student loans this year

This year, instead of scrambling to consolidate student loans by July 1, the smart money is on waiting until after that date -- because interest rates are expected to drop.

The catch: Fewer lenders are offering loan consolidation.

Every July 1, interest rates reset for the year for variable rate Stafford loans for students and PLUS loans for parents. Stafford and PLUS loans made after July 1, 2006 are at fixed rates and not subject to consolidation.

Interest rates on the older loans are tied to the interest on three-month Treasury bills based on the last auction in May. Until this year, interest rates have risen every year.

Why would you want to consolidate variable rate student loans?

3 reasons to consolidate:
To lock in a lower fixed interest rate.
To extend the life of the loan, from 10 years to up to 30 years, so monthly payments will be lower. But remember, a longer loan term means you'll pay more money overall.
To simplify your life by combining as many of your loans as possible into one payment.

A mad dash to lock in rates
That anticipated jump has brought on a mad dash each year during the last week of June to consolidate loans and lock in the current year's lower interest rate. This year, however, interest rates are expected to drop about 3 percentage points after July 1, from around 7 percent to about 4 percent, says Mark Kantrowitz, publisher of the student financial aid Web site, FinAid.org.

"In previous years, there has always been a rush to get the paperwork in before the June 30 midnight deadline," Kantrowitz says. "This year, July 1 is not the end point. It's the starting point."

Lenders dropping consolidation
You may be out of luck if your current lender has dropped out of consolidation loans as part of the Federal Family Education Loan Program, or FFELP. "Lenders representing 83 percent of fiscal year 2007 volume have suspended participation in consolidation loans -- and I don't understand why the other 17 percent are still making consolidation loans. If the lender isn't out of it now, they will be out of it by July 1," says Kantrowitz.

That's because consolidation loans are putting lenders in the red. "Existing consolidation loans, even for banks, are not profitable," Kantrowitz says. "The joke is, 'Congress took away half the lenders' profit and the credit crisis took away the other half.'"

The College Cost Reduction and Access Act of 2007 cut subsidies to lenders, eating into their already thin profit margins. As for the rest of the profit margin: The subprime mortgage crisis has rippled through the lending industry, driving up the cost of funds.

"Every time a lender makes a consolidation loan, they're losing money," Kantrowitz says. "It's been a riches to rags story for these lenders."

How to consolidate
Wait until July 1.
Check with your current lender.
Go online.
Consider unified lending.
Try to reduce the loan's term.

But although new students, especially those with FICO scores below 650, may have trouble getting loans, people who already have loans should have no trouble consolidating, according to Kantrowitz and the Department of Education. Here's what to do:

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Wait until July 1
Don't even start the consolidation paperwork until July 1. "Wait until July 1 to make sure you're not going to have a lender who files the paperwork too soon and locks in your loans at the higher rate," Kantrowitz says. And if you have a Perkins loan, investigate carefully before consolidating because consolidation eliminates some Perkins loan benefits.

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