Two of the top questions we get when doing student loan presentations and workshops for various programs across the country are: “What is student loan consolidation?” followed up by "Should I consolidate my student loans?"
This article covers the 4 topics you need to know about student loan consolidation, including:
Student loan consolidation occurs when you have multiple loans and you merge them into one aggregate loan. When it comes to student loans, the most common debt consolidation is done through a direct consolidation loan. A direct consolidation loan is a government program that allows you to combine multiple federal education loans into a single loan.
The resulting interest rate is a weighted average of your prior loan rates. For example, let’s assume you have two loans, each with balances of $10,000. One has an interest rate of 6% and the other has a rate of 8%. If you consolidated the two loans, your new loan would have a principal balance of $20,000 and a 7% interest rate.
The key thing to understand here is that consolidation, by itself, neither reduces your monthly payments nor save you money.
As we saw in the prior example, consolidating by itself does not provide any monetary benefit to the borrower. However, it does save the person the headache of having to deal with multiple loan servicers if the loans are spread across different parties. Many students find they may have anywhere from 5 to 30 different loans when they graduate. In addition, these loans could be serviced by multiple companies (i.e., the companies that you see on your statements, such as Navient, Great Lakes, Nelnet, etc…). Consolidation keeps the loans in one place.
For this reason, many “older” individuals say to consolidate so that way you only have to write one check each month. If your friends are telling you to consolidate it is likely they heard that advice from an individual that is from an “older” generation.
Now days, you do not have to worry about writing checks. It is very easy to set up automatic withdrawals. Therefore, you do not need to consolidate your loans. In fact, you most likely want to avoid consolidating your loans especially if you remain in your Federal loans.
There are two primary reasons to avoid consolidating your loans:
1. If you are trying to save money and are making prepayments, you can no longer target individual student loans if you consolidate. For example, to save the most money, you would want to pay off the highest interest rate loan first. However, this is no longer possible because you would no longer have multiple loans after you consolidate. You would only have one loan with one blended interest rate.
2. You may have less financial flexibility in the future. For example, assume you have two loans each with a required monthly payments of $500 (combined, your required monthly payment is $1,000). You may be prepaying one of the loans to try to pay it off as soon as possible. When you finally pay off one of the loans, you would then be left with the other loan and a required monthly payment of $500. If you consolidate, you are stuck making a required monthly payment of $1,000 until the loans are completely paid. Therefore, you potentially have more financial flexibility in the future if you do not consolidate your student loans.
There are two reasons why one would want to consolidate your student loans:
1. If you are going to refinance your loans, it may be beneficial to consolidate and forego the financial flexibility because you can save a good amount of money by refinancing and consolidating your loans. This is a tough decision to make and why many individuals choose to work with FitBUX. We help individuals customize their student loan strategy and provide them with the tools and info they need to decide if refinancing and consolidating is worth giving up the financial flexibility.
2. Depending on when your loans were disbursed, you may have to consolidate your loans to take advantage of various Federal income driven repayment plans (“IDR”). If you do this, be sure that you plan on using IDR for the entire repayment period or plan on refinancing out of your Federal loans at a later date. Deciding to use IDR versus paying down your loans is a tough choice. At FitBUX, our unique tools have helped hundreds of clients decide if going on IDR or paying down their loans is the right choice based on their personal financial situation.
If you are interested in developing a student loan repayment plan that is customized to you, you can visit www.fitbux.com and become a member today for free.