In a letter sent to the American Council on Education on April 15, Sen. Edward Kennedy, D-Mass., the chairman of the Senate Education Committee, urged colleges to sign up for the Department of Education’s Federal Direct Loan Program as a preventive measure against the potential funding inadequacies within the Federal Family Education Loan Program.

His recommendation to colleges and universities to enroll in the direct-lending program as a backup option for student loan funding is yet another one of Kennedy’s attempts to help protect students against a federal funding nightmare this fall.

Kennedy has also introduced the Strengthening Student Aid Act of 2008 into the Senate that would, in part, allow the federal government to inject liquidity into the student loan market and enable the Department of Education to purchase FFELP loans from failing lenders.

Kennedy’s efforts to help secure the federal student loan sector come at a time when almost 50 FFELP lenders have suspended their federal student loan programs in recent months, including 21 of the top originators of federal student loans and five of the largest holders of student loan portfolios, according to FinAid.org.

Several schools had already made the move to the Direct Loan Program before Kennedy sent his letter to the ACE, including Pennsylvania State University, which, at $276 million, has a substantial federal student loan volume. Secretary of Education Margaret Spellings has assured schools that the Education Department is equipped to handle double the volume within the Direct Loan Program, if necessary.

If you plan to graduate from college this spring, your mailbox may soon be filled with congratulatory cards from family friends, checks from distant relatives and reminders from your alma mater that your diploma will be rescinded unless you pay your overdue parking tickets. But if you borrowed to pay for college, much of your mail will come from lenders, urging you to consolidate your student loans.
Loan consolidation pitches aren’t new. For years, loan consolidation has allowed borrowers to reduce their monthly payments and avoid interest-rate increases. But lenders will be even more aggressive this year than in the past, predicts Kevin Walker, CEO of SimpleTuition, a loan comparison website.

In part, that’s because a law enacted last year eliminated the decades-old “single-holder” rule. That rule required borrowers who had all their federal student loans with one lender and wanted to consolidate to use that lender. Now, borrowers can consolidate with any lender. Smaller lenders are eager to lure student loans from the major players, Walker says.

In addition, lenders will have to work harder this year to convince borrowers that they should consolidate their loans. In the past, consolidation let borrowers lock in interest rates for the life of their loans, avoiding future increases. But last year, Congress eliminated variable rates for federal Stafford loans. All loans issued after July 1, 2006, have a fixed rate of 6.8%, so consolidating no longer affects the interest rate those borrowers will pay.

Why consolidate?

While there are still advantages to loan consolidation, recent investigations into some lenders’ marketing tactics have pointed up the need for vigilance. Rep. George Miller, D-Calif., chairman of the House Education and Labor Committee, has asked the Federal Trade Commission to investigate “unfair and deceptive” marketing practices by lenders seeking to consolidate student loans. And New York Attorney General Andrew Cuomo is investigating whether some college alumni groups received payments from Nelnet, a major loan consolidator, to steer students to Nelnet.

Reasons to consider loan consolidation:

•You still have variable-rate loans. Unless they’ve already consolidated, this year’s graduating seniors will have a combination of variable-rate and fixed-rate loans, says Rob LaBreche, president of consumer marketing for College Loan Corp. By consolidating, you can lock in the rate on the variable-rate loans, avoiding future rate increases.

If you consolidate your variable-rate loans during your grace period — the six-month window before you’re required to start paying off your loans — you can lock in a rate of 6.54%. If you include your fixed-rate loan in the consolidation, your rate will be 6.875%, Walker says.

The new rate for variable-rate loans, which is tied to short-term Treasury bills, will be calculated at the end of May. Mark Kantrowitz, founder of FinAid.org, predicts that the repayment rate for variable-rate Stafford loans will rise to 7.2% on July 1. But many lenders let you hedge your bets. Lenders with “best rates” programs will accept your application but won’t process it until the new rate is determined. If the new rate is higher, they’ll consolidate your loans before July 1; if the rate falls, they’ll wait until after July 1.

•Lower payments. The standard repayment for a federal Stafford loan is 10 years. By consolidating, you can extend the term to up to 30 years, thereby reducing your monthly payments.

If you’re worried that you can’t afford your monthly payments, consolidating will make your debt more manageable. It’s important to understand, though, that extending the term of your loan will increase the amount of interest you’ll pay over the course of the loan. Ideally, you should increase your monthly payments as soon as your finances improve.

•Fewer bills to pay. If you have loans with several lenders, consolidation allows you to combine them into one loan.

•Borrower benefits. Even though the maximum rate for Stafford loans is set by the federal government, some lenders offer discounts for good behavior. Most will cut your interest rate by a quarter point if you agree to have your payments automatically deducted from a bank account. And many will reduce your rate by 1 percentage point once you’ve made a certain number of consecutive on-time payments (see box).

If your current lender doesn’t offer discounts, consolidating with a lender that does could save you money. But be sure to read the fine print, Walker says. Ask the lender how it defines an on-time payment and whether your discount can be revoked if you make a late payment in the future.

“Borrower benefits have the potential to save you hundreds, if not thousands, of dollars,” Kantrowitz says. “But you need to be very realistic about your ability to get those benefits.”

by Sandra Block