A guide for student loan consolidation
Student loan consolidation may not be the silver bullet solution that it used to be and can be quite daunting. However, consolidation can still offer some benefits depending on your situation.
First of all, student loan consolidation can simplify your finances. By consolidating your student loans, you roll all of them into one bigger loan. This means you’ll have just one loan to keep track of and pay off instead of several ones. This helps to reduce late or missed payments. There’s also the possibility of securing a lower or fixed rate for your student loan consolidation debt.
About a decade ago, consolidating your student loan was perhaps one of the smartest financial decisions you could ever make. However, many things have changed since then.
To find out if consolidating your student loan is the right choice for you, take a look at some of the current student consolidation pros and cons, and whether it will actually save you money.
Key points on student loan consolidation
Here are some things you might want to keep in mind.
1. One of the best reasons to consolidate student loans is that it lets you stay organized. You now make one payment on one big loan instead of a couple of separate payments on several smaller loans. This will help prevent missed or late payments which makes consolidating your student loans worth it.
2. Consolidating federal student loans issued after 2006 with a federal student consolidation loan won’t save you any money because your loans already have fixed rates. You might be able to lower your monthly payments by choosing a longer repayment term, but this will cost you more in interest in the long run.
3. Consolidating your student loans with a private student loan consolidation company can potentially save you more depending on current interest rates. With private student loan consolidation, you’ll need good credit to qualify for a good interest rate. A variable rate loan will have a lower interest rate in the beginning, but interest rate could rise over time. A fixed rate consolidation loan may be higher to start with but you won’t have to worry about the interest rate increasing and having to pay more later on.
4. In general, steer clear of consolidating federal student loans with a private lending company unless you get an unbeatable rate. Federal student loans have many valuable fringe benefits that private loans don’t offer.
Rising cost of college and student debts
College education has never been more expensive. According to The College Board, the price for one year at a standard private college has jumped 146% in the last three decades to $31,231, while the four-year public school cost has increases insanely by 225% to $9,139. Those figures have been adjusted for inflation, otherwise they would be obscenely high. The figures only include schooling fees and not living expenses.
It comes as no surprise that student loan debt is on the rise too. In 2013, 59% of graduates from four-year public colleges had borrowed money to help them get through school, up from 52% in 2001. Their average debt load had increased 24% within a decade to $25,600, according to The College Board. If you add private school grads into the mix, the average American owes $29,000 in student loans.
We must not forget that these numbers are averages. Some students managed to earn their degrees with far less debt. On the other hand, some accumulate a lot more. No matter where you are on the spectrum, being informed can help you stay organized. It can help you figure out the best way to pay back your debt and maintain a reasonable lifestyle while doing it.
With student loan consolidation, you’ll have to be realistic about its benefits and downsides.
How to consolidate student loans
Consolidating your student loans can be a breath of fresh air. It allows you to consolidate (combine) multiple federal education loans into one. The result is a single monthly payment instead of multiple payments.
There are two main ways to do this: a private or a federal student consolidation loan
Federal student loan consolidation
You can consolidate almost any federal student loan using the direct consolidation loan program. However, you can’t include any loans from private lending companies or any PLUS loans borrowed by your parents on your behalf.
You may start consolidating your federal loans any time you wish after your graduation, leaving school or dropping below half-time enrollment. You probably don’t have to undergo a credit check to start consolidating your student loan. The interest rate on a federal student consolidation loan is fixed throughout the life of your loan.
However, it varies from one person to another. Reason being the interest rate is based on the interest rates of the loans you’re consolidating. You’ll have to pay the weighted average of those rates rounded up to the nearest 1/8th of a percentage point.
Private student loan consolidation
Various private lenders also offer private student loan consolidation. Some even allow you to include federal student loans in a private consolidation loan.
If you don’t have a long or strong credit history, as is the case with many students and recent graduates, you may not qualify for private student loan consolidation. You might be required to get a co-signer with better credit to secure a lower interest rate.
The interest rate on your private consolidation loan can be variable or fixed. We’ll discuss more on this later in the post.
Pros and cons of student loan consolidation
Student loan consolidation PROS
1. Depending on how many different loans you’re juggling with, keeping track of just one bill and payment due date instead of several can be a big relief, especially if you’re a recent student who is not quite used to the monthly grind of paying bills and managing finances.
2. You may get to choose a repayment plan that’s the best fit for your financial situation. For example, federal student consolidation loans offer several payment plans that take your income into account.
3. Consolidating may leave you with a total monthly payment that’s lower than what you were paying for your loans separately. In some cases, it can also save you money in the long run though that’s an unlikely scenario with federal consolidation.
Student loan consolidation CONS
1. The major downside of student loan consolidation is that you may end up paying more money over the life of your loan if you decide on a longer repayment schedule to make your monthly payments more manageable.
2. As you may gain repayment plan options with consolidation loans, you may lose access to other repayment plans benefits such as interest rate discounts or loan forgiveness, forbearance and deferment options. This can be a concern especially if you’re consolidating a federal student loan with a private lending company as federal loans are typically set up with far better borrower protection than private loans.
3. Consolidating your student loans may often mean that you’re locking in your interest rate. This can either work for or against you, depending on the current interest rate and whether your loans already have fixed rates or not. However, given that you can consolidate only once, it is a factor that’s worth careful consideration.
Does student loan consolidation help save money?
Truth be told, this benefit of student loan consolidation really depends on your new interest rate and any fees that the lending company charges. When lending companies claim that they can help you save money with student loan consolidation, they usually mean they can lower your monthly payments by stretching out your term, for instance from 10 years to 20 years. That actually means you’ll pay more money in the long run.
To better answer this question, we’ll look separately at whether consolidating federal student loans and private student loans can save you money.
Will federal consolidation save you money?
Let’s say the year is 2005 and you are about to consolidate around $17,500 in student loans. In 2005 federal student loan rates were still variable and back then interest rates were at a historic low. So in this situation, consolidating is a no-brainer. You’d be able to consolidate all your student loans during your grace period at around 2.875% interest rate, which would have been locked throughout the lifespan of the loan.
Since 2006, however, all federal student loans have been issued with fixed interest rates throughout the life of the loan. Which means federal student loan consolidation now will not save you the money that you would have saved in 2005. Today, unless you’re including older loans that still have high or variable rates, consolidating federal student loans will simply combine loans that already have fixed interest rates.
You could see some minor savings, or you could end up paying a little bit more. This is because of the way your new interest rate will be averaged and rounded off. It’s a negligible amount either way.
For instance, you’ve three federal student loans:
1. Loan A is a $10,000 loan that you took out in 2013 at a fixed 4.5% interest rate.
2. Loan B is a $10,000 loan that you took out in 2014 at a fixed 3.4% interest rate.
3. Loan C is a $5,000 loan that you took out in 2015 at a fixed 6.8% interest rate.
If you consolidate these loans, that will leave you with one loan for $25,000 at an interest rate based on the weighted average of the three loans interest rates rounded up to the nearest 1/8th of a percentage point. The weighted average means the high rate on the smaller $5,000 loan counts less compared to the others.
In that case, the new interest rate on the consolidation loan would be 4.625%.
Total paid amount
Here’s what your total paid amount would look like if you paid off each loan separately using a standard 10-year repayment plan:
|Monthly payment||Total repaid|
|Loan A ($10,000 at 4.5%)||$103.64||$12,436.56|
|Loan B ($10,000 at 3.4%)||$98.42||$11,810.13|
|Loan C ($5,000 at 6.8%)||$57.54||$6,904.83|
When we add the amount paid for each separate loan with a ten-year repayment plan at a combined monthly payment of about $260, the total becomes more than $31,150.
Now let’s compare the $25,000 consolidation loan with a 4.625% interest rate. By consolidating, you’ll actually pay $31,272 over the full life of the loan with a monthly payment of $260.61. As you can see, consolidating actually costs you about $120 more in this case – about a dollar more every month for 10 years.
A note on longer repayment terms
The example above compares paying down a consolidation loan and paying your loans separately, keeping the repayment term the same. If you consolidate and afterwards lengthen your loan term, it will lower your monthly payment. However, it’s likely that you’ll pay more in the long run.
If you are to pay off that $25,000 consolidation loan over 20 years instead of 10, your monthly payments would drop to about $160, which will free up an extra $100 a month. If you’re falling behind on other bills or need to tackle high-interest credit card debts, this can be quite helpful. Once you’re in a better financial position, you can always start paying more than the minimum due on your loan.
However, if it takes you 20 years to pay back, you’ll pay $38,366 over the life of the loan – a full $7,000 more than you would have paid on a 10-year repayment schedule.
Will private student loan consolidation let you save money?
Some banks and other non-government lending companies will consolidate your student loans. Some of which will allow you to mix some federal student loans as well. (However, you should remember that the reverse is not possible – you cannot consolidate any private student loans using a federal consolidation loan.)
If you’re thinking of consolidating both types of loans through a private lender, you should weigh the pros and cons really carefully. Usually, federal student loans offer better interest rates and other perks, such as more repayment plans and hardship options like forbearance and deferment compared to private loans. this is especially true for students with poor or little credit history. Consolidating a federal loan into a private one will mean that you may lose some or even all of those benefits.
When applying for a private consolidation loan, your credit is the key to determining the kind of interest rate you’ll receive, and whether consolidation will save you money or not.
For students with poor credit or a very short credit history, it can be really tough to qualify for a good rate without a co-signer who has a good credit. A co-signer guarantees that he or she will pay the loan for you if you can’t pay it back yourself. That puts a co-signer in a very tricky proposition as it can ruin relationships if you were to make someone else carry the burden of your debt. Therefore, always pay up and don’t put someone else in a spot.
Which is better: fixed or variable interest rate?
As mentioned before, you won’t have to consider this if you’re using the federal student loan consolidation program because your interest rate will be fixed. However, if you’re looking to consolidate loans with a private lender, the choices available could be wider as many private lenders also offer variable interest rates that could fluctuate. Let’s look at some pros and cons of each to consider.
Fixed rate consolidation loans:
1. These have a higher interest rate than variable-rate options, at least initially. The lending company knows it will be unable to capitalize on interest-rate hikes down the road, so this is the price you pay for security.
2. They’re ideal for budgeting because you know your payment will be the same from month to month and year to year. It is just easy to plan ahead.
3. This might be the best option if you value the security that comes with knowing that your rate (and your payments) won’t change.
Variable rate consolidation loans
1. Variable rates have a lower interest rate, but that rate can change. Your rate will be pegged to an interest-rate index ( or a set number of percentage points above such an index). As the index fluctuates over time, so will your interest rate and therefore your monthly payment. This can work in your favor when interest rates go down, but it can become pretty costly when rates climb.
2. They are not as ideal for budgeting because your payment can change along with your interest rate.
3. These might be the best choice if you’re willing to risk the long-term security of a fixed rate for short-term savings, or if you can pay off your loan in a reasonably short time to capitalize on the low initial rate.
You’ll want to see what index your variable loan rate will be tied to. It’s often the federal prime rate or the one-month London Interbank Offered Rate (LIBOR). The prime rate has held steady at 3.25% since 2009, a low unmatched since the 1950s. The LIBOR, at 0.18% today, is starting to gradually rise in 2015 after hitting a historic low last year.
Most experts agree that interest rates have nowhere to go but up. However, the question is how much and how fast they may rise.
Two examples of private student loan consolidation
Consolidating your student loans can look pretty different depending on whether you choose a variable rate or fixed rate consolidation loan. We’ll explore these two scenarios with the same set of loans.
Example 1: Fixed rate private consolidation loan
Let’s first look at consolidating your loans with a private lending company that offers you a fixed rate consolidation loan.
In this example, let’s assume you’ve three private student loans: Loan D, a $5,000 loan at a 5% interest rate; Loan E, a $10,000 loan at 8%; and Loan F, a $15,000 loan at 12%. Assuming a 10-year repayment plan, here is what the monthly payments and total amount repaid on those loans would look like:
|Monthly payment||Total repaid|
|Loan D ($5,000 at 5%)||$53.03||$6,364.03|
|Loan E ($10,000 at 8%)||$121.33||$14,559.16|
|Loan F ($15,000 at 12%)||$215.21||$25,824.38|
As you can see, paying each of these loans separately will result in close to $390 in monthly payments and a total amount paid of over $46,700.
Let’s say you decide to consolidate your loans. You have pretty good credit and qualify for a fixed interest rate of 7.5% on your new $30,000 loan. Say you can stick to the 10-year repayment term and consolidating at this interest rate will mean a monthly payment of about $356 and a total repaid of about $42,730. That way you’ll save about $34 a month and $4,000 over the life of the loan.
Example 2: Variable rate private consolidation loan
Let’s say your good credit means you qualify for a 4% variable interest rate on that $30,000 consolidation loan. Assuming your interest rate stays at 4% for a year, and then it begins to climb 1% a year until it hits a rate cap of 10%. (Most lending companies will have a rate cap in place on variable rate student loans to protect you in case rates rise an inordinate amount.)
Again, let’s assume a 10-year repayment plan. Y’ll make payments ranging from a low of about $304 a month to a high of about $365 a month and total payments of about $41,460. As you can see, even though interest rates rose while the loan was in repayment, the variable rate resulted in the most total savings.
We made two crucial assumptions in both cases. First, you are credit-worthy enough to qualify for an interest rate on the lower end of the spectrum. Second, you can stick to a standard 10-year repayment plan for your consolidation loan instead of lengthening the term.
If you can’t qualify for a low interest rate or keep your repayment term reasonable, private student loan consolidation most likely won’t save you any money – in fact, it could cost you a lot more in the long run.
Also don’t forget that a variable interest rate is a gamble that becomes riskier the longer it takes you to pay off your loan. You should always check what kind of rate cap is in place to protect you.
How does student loan consolidation affect your credit score?
Student loan consolidation can affect your credit just like most big financial decisions, but not significantly enough that to be a major factor in your decision. Since you won’t be juggling as many separate bills, consolidation can make it easier for you to make on-time payments. Staying on top of payments and making them reliably each month is a proven way to raise your credit score over time as it demonstrates to creditors that you are a responsible borrower.
However, there are a few minor ways consolidation can hurt your credit. If a lending company makes a hard inquiry to check your credit – the basic process of running your credit score to see if you qualify for a loan – it can drop your credit score a few points. Though the damage will be negligible and short-lived as long as several lenders aren’t making hard inquiries around at the same time.
It’s also possible that when you replace your old loans with a new one, it can hurt your score by lowering your average account age. That’s because 15% of your credit score is based on the length of your credit history.
Consolidating and paying down your loan on time will actually raise your credit score in the long run as you prove your ability to handle debt responsibly.
Six strategies for paying off student loans faster
By now, it’s probably pretty clear that consolidation doesn’t offer many guarantees when it comes to saving money on your student loans. However, there are several strategies that can do just that.
Don’t forget to cover your other financial bases before you embark on any aggressive student loan repayment plan. That means being able to pay your bills, but also having an emergency fund, beginning to save for retirement and prioritizing debt that has an interest rate higher than your student loans.
You should remember that your student loans are likely to have lower interest rates and more favorable payment terms than many other kinds of debt – especially credit cards.
For instance, if you have $10,000 in credit card debt with a 19% interest rate, it doesn’t make much financial sense to spend your extra money financing a student loan with a single-digit interest rate when you’re only making minimum payments on the credit card debt.
Strategy #1: Choose the shortest repayment term you can manage
Your loan’s repayment term is the time you have to pay back the loan. Ten years is the standard, but some recent graduates extend their term to 15, 20, or even 25 years in order to keep their monthly payments low. This is a big temptation with student loan consolidation because your new monthly payment can look quite intimidating once your loans are combined.
If you choose a longer loan term, it can bring you some relief in the form of lower monthly payments, which can help you make faster progress paying down higher-interest credit card debt. However, it dramatically increases the total amount you repay throughout the loan tenure since interest continues to accrue on the unpaid balance.
Now let’s go back to Loan A, the $10,000 federal loan with a fixed interest rate of 4.5% and see how the loan term affects how much you would pay monthly and over the life of the loan.
|Term length||Monthly payment||Total repaid|
As you can see, you can cut your monthly payments in half with the 25-year term, but you’ll have to pay more than $4,200 over the life of the loan in order to to it.
Strategy #2: Pay more than you need to each month
Again, let’s look at Loan A. Under the standard 10-year repayment plan, you would pay just under $104 a month for a total of $12,437 over the 10 years period. But if you pay a bit extra money each month this is what’s going to happen:
|Monthly payment||Total paid||Time saved||Total saved|
|$113.64 (an extra $10)||$12,158.34||13 months||$278.27|
|$123.64 (an extra $20)||$11,937.99||23 months||$498.62|
|$153.64 (an extra $50)||$11,485.78||45 months||$950.83|
|$203.64 (an extra $100)||$11,072.91||65 months||$1,363.70|
As you can see, paying just $10 more each month will save you a few hundred dollars over the life of the loan, and you’ll be free of it a year earlier. If you can be really aggressive, paying an extra $100 a month can save you more than $1,300 over the life of the loan — and you’ll have it paid off in just four and a half years instead of ten
Strategy #3: Prioritize your most expensive loan
Using this strategy, known as the debt avalanche, suggests that you haven’t consolidated all of your loans, because you’ll be attacking the loan with the highest interest rate most aggressively.
In the example below, we’ll go back to Loans D, E, and F. Loan D was the $5,000 loan at 5%, Loan E was a $10,000 loan at 8%, and Loan F was a $15,000 loan at 12%. Let’s go with a 10-year repayment plan to see what monthly payments and total amounts repaid on those loans would look like:
|Monthly payment||Total repaid|
|Loan D ($5,000 at 5%)||$53.03||$6,364.03|
|Loan E ($10,000 at 8%)||$121.33||$14,559.16|
|Loan F ($15,000 at 12%)||$215.21||$25,824.38|
Let’s say you can pay more than $390 a month because you want to pay off the loans faster and reduce the total amount of interest you pay on them. You look at your budget and decide you can spare $550 a month for your debt – that’s roughly an extra $160 a month over the required payments.
If you finance the highest interest loan first (Loan F), you’ll be putting roughly $375 towards that loan each month (the minimum $215 plus the extra $160) while keeping the other payments the same as in the table above. That way, you’ll now be able to pay off Loan F in only four years and four months instead of 10 years.
Once you’re done with Loan F, you turn to Loan E. After 51 months of paying $121.33 a month, your balance is about $6,693. Now you have about $497 to throw toward Loan E (that’s your $550 loan payment budget minus the minimum monthly payment for Loan D, which you’re still paying). It is going to take just 15 more months to pay off Loan E at this rate.
Finally, for Loan D, which is at about $2,560 after paying $53 a month for 66 months. Now you can go at it with the entire $550 a month, which means you’ll need just five more months to pay off Loan D.
By paying a bit extra each month and prioritizing the loans based on their interest rates, you can pay them off in six years instead of 10, reclaiming four years of your life where you won’t have to make any student loan payments. And not only that, but you’ll save more than $8,000 in total interest compared to what you’d pay with a standard 10-year repayment plan.
Strategy #4: Prioritize your smallest loan
This strategy also assumes that you haven’t consolidated all of your loans, because you’ll be attacking focusing on the loan with the smallest balance first. This method is also known as the debt snowball.
We’ll once again use Loans D, E, and F for this example. You’ll go at your loans with the same extra $160 a month above those minimum monthly payments. This time, however, you start with the smallest balance: Loan D, the $5,000 loan at 5%. Putting in an extra $160 each month, on top of the original $53, means you’ll have it paid off in just two years. After that’s paid off, you turn your focus to Loan E. The balance is about $8,582 after making the $121.33 payments for two years. Now, you can redirect all the money you were paying toward Loan D and apply it to Loan E, on top of the minimum payment you’ve been making all along. Paying $335 a month, it will be gone in another 28 months.
Finally, you go to Loan F. The balance is about $10,472 after making those $215 minimum payments for 52 months. Now that you have no other loans to take care of, you can put in your whole $550 monthly budget towards it, and you’ll have it paid off in another 22 months.
So you’ll have all three loans paid off in 74 months instead of 120 months by paying a little more each month and starting with the smallest loan first. You’ll also save about $6,000 total in interest.
While we can’t say the results are as good as those of the debt avalanche plan, but they still make a huge difference. With the thrill of paying off two loans completely early, you’ll most likely be more motivated to stick with the aggressive payback plan. This is why some financial experts recommend the debt snowball over the avalanche method.
Strategy #5: Exploit any available discounts
Some lending companies may offer small breaks on your interest rate. The most common discounts are for making on-time payments over a certain period of time, setting up automatic payments, or having other existing accounts with the lender. Some lending companies may waive any existing loan origination fees. You must make sure you know which discounts your lending company offers so you can make sure you take advantage of them.
Strategy #6: Explore student loan forgiveness
There’s a way to get a portion of your federal student loans forgiven, meaning you won’t have to pay backthat certain amount. It’s no surprise that this very tempting possibility comes with some hefty strings attached. Forgiveness is a likely possibility if you embark on a career in public service, move to certain locations, join the military or volunteer with certain organizations.
Is it worth it to consolidate student loans? The answer could go either way. Here’s a summary to help you decide.
1. Consolidating your loans with the federal student loan consolidation program won’t save or cost you any significant amount of money. That’s because federal student loans borrowed after 2006 already have fixed rates, and your new interest rate will be simply a weighted average of the old ones.
2. Consolidating your loans with a private lender may save or cost you money. Very good credit is required to have a shot at savings (or a co-signer who’s credit-worthy). A tempting variable rate can be risky unless you know you can pay off your new loan in a relatively short time; fixed rates eliminate the risk of rising payments but they’ll be slightly higher.
3. If it’s hard for you to keep track of your finances, juggling multiple bills and remembering payment due dates, student loan consolidation is 100% worthwhile as it will help you stay organized and reduce the possibility of falling behind on payments.
4. It’s not wise to use consolidation as an excuse to drastically lengthen your repayment terms. By doing this, you will just pay more interest over the life of the loan. Choose the shortest term you can manage.
5. You can save a hefty amount on your student loans using strategies that don’t require consolidation, such as paying more than you’re required to each month. Variations on this strategy include targeting the smallest balance first, or paying down your highest-interest loan first. If you want to give either of these tactics a try, you won’t need to consolidate.
It’s safe to say that the days of saving a significant amount of money by consolidating your student loans with a lower interest rate are over. However, there’re still many reasons to consolidate even though it may cost more in the long run. There are advantages such as locking in interest rates on private loans, simplifying payments, extending loan term to lower monthly payments and having more financial breathing room each month.