Thursday, December 13, 2007

Federal Student Loan Consolidation

The end of the semester is always a useful time to remind people about options for consolidating federal student loans. A few starting points (general do’s and don’ts):

- You CANNOT consolidate until you graduate.
- If you consolidated in the past to take advantage of lower rates (good for you!), you CAN [and want to] reconsolidate assuming you have borrowed something since then.
- You CAN consolidate wherever you want – you are not required to use your lender even if they are your only lending source.
- NEVER consolidate federal loans with private loans (for those with private loans, I have a link in the resource section to provide information about refinancing them).
- ALWAYS shop around for the program that will best meet your needs.

The most commonly asked question is always where to do it. Keep in mind that as long as you are doing a federal consolidation loan (which is the only thing you should do), the only difference between the products are (1) who you are paying each month; and (2) the financial benefits the companies offer [or don’t offer]. Everything else about the loans (eligibility for deferment, etc.) are identical, the lender chosen won’t offer anything better than another. Those two items listed are the only real differences with one ‘new’ (as of October 1, 2007) exception which I’ll outline later.

For the vast majority of people, item one (who you pay) is obviously not a real big deal – whether I make my payment to Sallie Mae, MOHELA, Dept of Ed, Citibank, or anyone else doesn’t matter. The second item (financial difference in benefits offered) is really the primary criteria that should be used in evaluating loan consolidation offers. How you look at the products is based upon how you intend to repay your loans.

If you plan to repay your debts quickly (2 years or less).
Find the program that offers the largest “up front” (principal balance) credit. Key Bank used to offer a 5% principal balance credit; I’ve been told this is still available, but it is not listed on their website, so you’ll want to do some homework. I’ve never seen a principal balance credit larger than this.

If you plan to repay your debts over time (graduated/extended).
If paying over time, an upfront benefit will be much less meaningful than a reduction in your interest rate. There are two states that currently offer the most substantial interest rate incentives. New Hampshire (which is open to anyone) offers a .5% reduction for auto payment, an additional 1% reduction when repayment begins, and a $250 principal balance reduction after 12 consecutive on-time payments (so the total rate benefit is 1.5%, given on day one). North Carolina offers a slightly larger benefit (2.25%), but the benefit is provided in a tiered fashion over time (.25% reduction for paying automatically; .5% additional interest rate reduction after 24 on-time payments, .5% additional after 12 more months (36 total), and 1% more after 12 more months (48 total) – 2.25% total rate reduction after 4 years). Obviously if I’m planning on repaying my debt in ~5 years, a program like New Hampshire where that benefit is immediate would serve me better than a principal balance credit and will also serve me better than a program like North Carolina where I have to wait 4 years to fully realize the benefit. North Carolina is going to best serve those intending to utilize an extended repayment (12+ years) option. North Carolina does require people to have a “state connection” in order to utilize their program. The easiest way to create that connection is to open up a 529 college savings plan for a child, sibling, niece/nephew – you can do so online in about 5 minutes with as little as $25. Once that is opened, you then have your connection and are eligible for their State Consolidation program.

I mentioned above that there is one exception where I would not consolidate with a company offering the best financial incentives – that case would exist if I am being hired [and plan to continue working] as a “public service” professional. The best working definition I’ve seen is at (is still being crafted). If I fit this definition, then I am the “potential” exception. An example of who this new program would serve is a student that just completed a graduate program in a field like social work; has a high level of student loan debt working in a field where their salary will never likely dramatically increase over time. This is the prime person for this program. How it works: Consolidate with the Department of Education (ONLY scenario where consolidating with the Dept of Ed will make financial sense) and select the income sensitive repayment. After 10 years of payment, the remaining balance will then be forgiven [you’ll be responsible for taxes on the forgiven amount, but the remaining loan amount will be wiped away]. This scenario is ONLY available if you use the income sensitive repayment option and ONLY if you consolidate through the Dept of Education. Even if I am a public service employee, if my debt level will not require me to repay my debt over more than a 10 year period, I will be better served by one of the other programs previously outlined!

Additional Resources.
Accessing your Federal Loan Info
OFS Consolidation Resources (Weighted interest rate calculator, repayment plan information, payment calculator, and other resources)
Private Loan Consolidation (READ PRIOR TO DOING – often not smart)

Thursday, December 6, 2007

Credit Cards ('Risk-Based Re-Pricing')

Congress has been talking about revising current regulations surrounding credit cards for several months now. Some members of Congress are being very vocal about current practices in the credit card industry (practices described by one critic as “abusive and confusing”). You’re likely aware of one common practice referred to as ‘universal default clause’ – a provision in a card agreement that enables the cardholder to raise your rate if you miss a payment to anyone [doesn’t need to be that particular card]. Universal Default is a concept I’ve outlined in prior tips on card management.

Earlier this week I read about a Senate subcommittee scrutinizing a newer practice that was being called “risk-based re-pricing.” Ultimately, this takes universal default one step further. The idea behind universal default was to raise the interest rate because of the increased risk placed on the card company; with risk-based re-pricing, rather than raising rates due to missed payments, rates can be raised in any circumstance where your credit score is lower than it was when they initially gave you the card. Keep in mind that 30% is commonly the rate charged when one’s rate is raised! Obviously the high rates were of concern to the subcommittee, but they were also concerned about consumers having little notice of the increased rate [often automatically triggered by unexplained declines in ones credit score]. In some cases, merely opening another account (i.e., dept store card) triggered the downgrade in credit score … One of the curious cases cited was a consumer that had four credit cards from the same company (the argument is that she should have similar rates based upon this type of model); her current interest rates: 8%, 14%, 19%, and 27%.

My opinion – legislative change often never occurs; I wonder how much of this “conversation” is in hopes that the credit card companies will change questionable practices on their own prior to changes in law. Not a bad start. Citigroup and Chase recently have said they will discontinue the practice (Citigroup has already stopped) and Chase will take effect in March. We’ll see if others follow suit.

What are legislators seeking? Ultimately, everything I’ve read really boils down to two requests:
(1) Clarity for Consumers. The Truth in Lending Act [specifically Regulation Z] is designed to promote consumer awareness of loan terms. The argument on the part of consumer advocates is that credit card billing and interest rate practices are much too complex for an “average” person to understand. The proposed rule change would require card issuers to ultimately redesign card applications and solicitations [enhancing disclosures] providing clearer [more easily understandable] information on fees.

(2) Mandatory Notification. The second item currently being requested would require card companies to give its customers at least 45 days notice before ‘penalty pricing’ (raising rates).

Additional Resources.
- AP Article: Credit Card Execs Defend Rate Policies
- Truth in Lending Act