Rates on Stafford, PLUS loans for college students are falling

— -- Everybody loves a bargain. That's why some folks will travel 10 miles to save 50 cents on a gallon of milk. But if you need to borrow money for college, you don't have to drive across town to get a good deal on student loans. Starting next month, the cost of borrowing from the federal government using Stafford loans will drop for thousands of college students.

On July 1, the interest rate for new subsidized Stafford loans for undergraduate students will drop to 5.6% from the current rate of 6%. This rate, which applies to loans issued between July 1 and June 30, 2010, will remain in effect for the life of the loan. Subsidized Stafford loans are available for borrowers who demonstrate financial need.

The reduction is part of a series of rate cuts embedded in a $20 billion college aid bill signed into law in 2007. The lower rate won't affect loans issued before July 1, says Bob Murray, spokesman for USA Funds, the USA's largest student loan guarantor. "If you're an undergraduate with a subsidized loan and got it last year, the rate is 6% and will stay 6% for the life of the loan," he says.

Rates for new unsubsidized Stafford loans, which are available for all students, will remain at 6.8%. However, all Stafford borrowers will get a break on upfront borrower fees, Murray says. On July 1, the maximum fee that lenders will be permitted to charge on Stafford loans disbursed between July 1 and June 30, 2010, will drop to 1.5% from 2%. Upfront fees are deducted from the loan amount when the loan is disbursed.

Lower rate for old loans

If you have federal student loans issued before July 1, 2006, there's even better news. On July 1, the repayment rate on those loans will drop to 2.48% from the current rate of 4.21%. Interest rates on federal PLUS loans — Parent Loan for Undergraduate Students — issued before July 1, 2006, will drop to 3.28% from 5.01%.

Borrowers who consolidate these loans after July 1 will lock in a rate of 2.5% for the life of the loan. Borrowers who are in their grace period, the six-month interval between graduation and the start of repayments, can lock in a rate of 2%. PLUS loan borrowers who consolidate can lock in a rate of 3.38%.

Rates on student loans issued before July 2006 are based on the rate for Treasury bills at the last auction in May. This year, the T-bill rate was 0.18% — "as close to zero as you can get," says Mark Kantrowitz, publisher of FinAid.org, a financial aid website. Since it's unlikely rates will go lower — they've already risen since the May auction — locking in current rates is a smart move.

You only get one chance to consolidate your student loans. If you've already consolidated, you can't reconsolidate and lower your rate.

Lenders aren't lining up to consolidate student loans. The credit crunch and a cut in federal subsidies have made these loans unprofitable, and lenders have, for the most part, abandoned the consolidation business, Kantrowitz says.

However, you can still consolidate your loans through the Federal Direct Loan Program.

There are two types of student loans: Federal Family Education Loans, which are offered by private lenders and guaranteed by the government, and Federal Direct student loans, which are offered directly to students at schools that participate in the direct lending program. You can consolidate FFEL loans through the Federal Direct Loan Program. You can find more information at www.loanconsolidation.ed.gov.

Federal vs. private

Even if you don't qualify for a subsidized student loan, a 6.8% fixed interest rate is probably better than you'll find in the private student loan market. Federal student loans also offer more flexible repayment terms than private loans.

Yet, every year, thousands of students who are eligible for federal student loans borrow using more costly private loans. One reason may be that private loans are easier to get, Kantrowitz says. To qualify for a federal student loans, you must fill out the Free Application for Federal Student Aid, or FAFSA, a voluminous document that requires you to provide detailed information about your finances.

The Obama administration has pledged to make the FAFSA more accessible. But in the meantime, if you plan to borrow, completing the FAFSA is worth the trouble, Kantrowitz says. You can find more information about the FAFSA at www.fafsa.ed.gov.

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com. Follow on Twitter: www.twitter.com/sandyblock