Starting in July, new ways to cut your student debt

July 1 is shaping up as a big celebration day for college students and recent graduates. That's when several perks for federal student loanholders take effect.

If you have student loans from the federal government, here's how you may be able to lower your payments and, potentially, your interest costs.

Cut monthly payments

One of the big perks of the 2007 College Cost Reduction and Access Act is the Income-Based Repayment program. Taking effect next Wednesday, the IBR allows college graduates with federal loans, including Staffords, Grad Plus, and Perkins, to lower their loan payments if they have enough debt compared to their incomes. (If it takes more than 15 percent of what you earn above 150 percent of the poverty level to pay your loans off in a standard ten years, you're in.) For most borrowers, the program reduces payments no more than 10 percent of their earnings.

For example, a single person earning $40,000 a year can expect to repay no more than $3,680 a year (9.2 percent) on their loans, according to IBRinfo.org. Here's where it gets tricky. If those payments aren't enough to cover interest costs, the unpaid interest will be added to the total amount owed. That would increase your debt. If you have Subsidized Stafford Loans, the federal government will pay the interest shortfall, but only for three years.

One of the big advantages of the program is that the term of the loan is capped. So as long as you make qualifying payments under IBR for 25 years, the rest of your debt is forgiven, no matter how big it is. If you work in public service – say, as a teacher or in a government job – the balance of the loan is forgiven after only 10 years.

Want more details? IBRinfo.org has more information, including a calculator to see if you meet the debt-income ratio.

Ready to switch? Contact your lender directly.

Lower interest rates

In addition to the new IBR program, other federal loan changes taking effect July 1 will increase the amount of grants available to needy students and reduce the interest rates on student loans.

For students who qualify for Pell Grants — usually reserved for families with incomes under $50,000 — the government is raising the maximum award from $4,731 to $5,350 for the upcoming school year.

Also, interest rates on new Subsidized Stafford loans (generally for families making under $80,000) drop nearly half a percentage point to 5.6 percent, starting Wednesday. Fill out the Free Application for Student Aid to see if you qualify for these forms of financial aid.

Consolidate, consolidate

Already graduated and have federal loans? Wait until July 1 to consolidate any variable-interest Stafford loans taken out before July 2006 — interest rates drop from the current 4.21 percent to as low as 1.88 percent for recent graduates still in their six-month grace period. The rate will be 2.48 percent for those who consolidate loans already in repayment.

Consolidation can make payments simpler and, sometimes, lower. For example, the financial aid site Fastweb calculates that a student who borrows a Stafford loan of $20,000 at a 6.8 percent interest rate with a standard 10-year repayment plan can expect to pay $7,619 in interest over the life of the loan; consolidating at a 2 percent rate would bring that down to $2,083.

To consolidate, fill out an online application at the Federal Direct Consolidation Loans site.

The caveat, of course, is that these new repayment options are for students with federal loans — not private ones, which an increasing number of students are using. According to the Project on Student Debt, 14 percent of undergraduates nationwide took out private loans in the 2007-2008 school year, up from 5 percent just four years earlier.

– Guest blogger Taylor Barnes is a Monitor contributor.