New Legislation May Lower Student Loan Interest Rates

529 plans are still recommended, however

If a new Democrat-sponsored bill becomes law, holders of student loans would pay less in interest. The College Student Relief Act of 2007 (HR 5), introduced by Rep. George Miller (D-California) with 211 cosponsors, would modify the Higher Education Act of 1965 by cutting in half the fixed interest rates on need-based Stafford loans for undergraduates over a five-year period. The bill passed the House on January 17. Interest rates would be cut according to the following schedule:

Date of loan disbursement Fixed interest rate
7/1/06 - 6/30/07 6.80%
7/1/07 - 6/30/08 6.12%
7/1/08 - 6/30/09 5.44%
7/1/09 - 6/30/10 4.76%
7/1/10 - 6/30/11 4.08%
7/1/11 - 6/30/12 3.40%

After June 30, 2012, the interest rate would in all probability revert back to the 6.80% fixed rate.

The legislation has been referred to the Senate Committee on Health, Education, Labor, and Pensions. While the eventual prospects for the legislation is not yet clear it does raise the following question: If conditions are favorable for student borrowers, should they still consider taking out an education loan even though they have funds in a 529 account?

According to Joe Hurley, founder of Savingforcollege.com, "many people wrongly assume that you must use your 529 dollars to directly pay college expenses, and if you decide to take an education loan you would have to keep your money inside the 529 plan to avoid tax and penalty." However, Hurley points out on his Web site that 529 withdrawals can still be tax-free even when college payments are made with other funds, such as education loans. "The law requires only that the 529 funds be withdrawn in the same year your beneficiary incurs qualifying college costs," Hurley writes.

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