Ballpark Estimate: No upfront costs, but you will pay more overall to increase loan term
If you owe multiple students loans to pay for education, you may be able to apply for a consolidation loan that will allow you to combine all of these obligations into one and make only one monthly payment. This can make it easier to pay off your balance, but – and there is a real but here — financial experts warn that you should do your homework before going this route, as this isn’t the best fit for all situations.
How It Works
A student consolidation loan is basically a contract to take out a new, bigger loan from one lender who in turn pays off all of your other loans. This means you only need to make one payment toward the total owed. You can also often stretch out the terms of the new loan, thereby lowering the monthly payment.
While this sounds good on paper, a loan consolidation is not always as beneficial as you might think. This is because you usually don’t significantly lower the interest rate when you consolidate. The original idea behind the consolidation was to allow students with variable rate loans to lock in a comparable fixed rate. However, now most student loans are fixed, so the cost savings is negligible if you stick with the same loan terms. Further, a consolidation often increases the life of the loan (for example, instead of having 10 years left to pay off a loan, you may take the new loan out for a 20 or 30 year period). Since the life becomes longer, you get lower payments since the total owed is divided up over a much longer time, but on the flip side, you also pay interest on the amount for a much longer time, so the total cost of the loan is also much higher when you factor this in. These are important points that should be considered when you look into consolidation.
Government vs. Private Loans
Before you begin researching a loan consolidation, it is important to consider the type of loans you want to merge. There are two categories: government (or federal) education loans and private education loans. Federal loans come with some important benefits. For instance, the interest can be tax deductible and there is typically an option to defer payments on this type of loan if you go back to school or lose your job or experience other financial hardship. Finally, in certain situations a federal loan can be forgiven. Private loans, on the other hand, are treated just like any other bank loan. Therefore, you wouldn’t want to consolidate federal and private loans together, since to do so would cause you to lose the government benefits.
Most graduates who have multiple federal or private student loans are eligible to refinance these into one. You can still be in the grace period before the loan repayment phase begins but you must have completed the educational program before you can apply for a consolidation. You can also actually have a poor credit rating and still qualify for a consolidation loan. This is important, since by consolidating you may actually be able to better manage your finances.
Parents who took out multiple educational loans for their children can also consolidate, and they do not need to wait until the student has graduated. It is worth noting, however, that parent and child loans cannot be combined into one. Neither can husband and wife loans. Only education loans that are taken out by the same borrower can be consolidated into one.
In addition, people who have already consolidated a loan can consolidate the consolidation again, but only if they are adding a new loan into the new consolidation. However, two separate consolidation loans may be combined into one larger consolidation.
What to Look For
If you are interested in a consolidation loan, you can shop online as well as talk to your local banks and other local lending institutions. You can also look to the federal government if you have federal loans. For instance, the US Dept. of Education offers Direct Consolidation loans, and you can also find consolidations through the Federal Family Education loan program.
You will want to find out all of the specifics involved in a loan consolidation, including any costs incurred, term of the loan, differing payment options, whether you can repay the loan early without penalty and what the minimum balance is to be eligible for a consolidation. (Note that some banks require a minimum owed of anywhere from $5,000 to $20,000 to take advantage of this option, but with a government consolidation loan, sometimes this requirement is waived.)
It is also important to note that recent legislation regarding consolidation loans has greatly affected the rules, availability and options, so borrowers may find it more difficult to find such a loan than they would have a decade ago.
Consolidation loans offer a range of payment options. You can often choose to extend the life of the loan beyond a standard 10-year arrangement to 20 or 30 years. You may also opt for a graduated repayment plan, which starts out very low and increases every few years, hopefully to coincide with your advancing income as your career progresses. You can also select an income-sensitive loan, which adjusts your payments based on your earnings so you most effectively manage your financial obligations.
What It Costs
There are generally no costs up front to taking out an educational loan consolidation. The costs incurred, however, are tied to the interest rate. The way a consolidation loan interest rate is set is to be an average of the rates of all of your loans. For example, if you have three loans, and one is at 7 percent, the second one is at 7.5 percent and the third one is at 8 percent, your new loan will combine the balances of all three loans and lock in a fixed rate of about 7.5 percent. While lenders may try to convince you that you will benefit by moving to this “lower” rate, if you do the math over the life of the loan, you should come out at about the same cost for interest when you average in the lowered and higher rates and settle at the median. Further, if you extend the life of the loan, let’s say from 10 years to 30 years, you are paying off the balance at 7.5 percent for an additional 20 years, so this steeply increases the cost of the loan over its lifetime.
Here is a more concrete illustration of how this would work. Let’s say that your three loans are all for 10 year terms and each has a balance of $10,000. With the three different Cost To Consolidate Student Loansinterest rates, your monthly payments for all three loans will total $356.14, and in 10 years you will have paid $12,736.41 in interest when the loan is repaid. If you consolidate these loans into one $30,000 loan with a fixed rate of 7.5 percent, your payment will be $356.11 (but you’ll only have to write one check for the total, instead of three) and the interest paid will be almost exactly the same as you would have paid, or $12,732.37. If you extend the loan to a 20 year term, though, your payment goes down to $241.68 a month, while the interest paid jumps to $28,002.07 (more than double what you would have paid) over the life of the loan.
Will You Benefit?
There are a variety of resources available online that can help you to determine if you a good candidate for a consolidation loan. Basically, if you are having trouble managing your financial obligations and it would be worth the added expense of stretching the payments out for longer or putting them on some type of a graduated schedule, then it may be a beneficial move. You can use a calculator available through FinAid’s Smart Student Guide to Financial Aid to compare your current situation with some consolidation options.
When to Beware
The Internet is ripe with unscrupulous lenders looking to scam graduates. Therefore, you should research any lender you are considering and make sure they are a highly-respected institution. Also make sure there aren’t unnecessary fees being built into the equation. That said, though, keep in mind that while legitimate loans don’t charge any fees upfront, some of them do have origination fees that must be counted in. But these fees will be part of the distribution of the funds and should not be charged to you initially. When it doubt, always double check with the Better Business Bureau, the Federal Deposit Insurance Commission or request more information from the financial aid office at the school you attended.