Student Loan Consolidation: 4 Things To Know

February 1, 2019 No comments exist

By Joseph Reinke, CFA, CEO of FitBUX

Two of the top questions we get at FitBUX are: “What is student loan consolidation?” and "Should I consolidate my student loans?"  We touch on this topic in our Student Loan Repayment guide.  However,  this article digs deeper into student loan consolidation.

This article covers the 4 topics you need to know about student loan consolidation, including:

1. What is student loan consolidation
2. Why people tell you to consolidate
3. Reasons why you wouldn’t want to consolidate
4. Reasons why you would want to consolidate

What is Student Loan Consolidation?

Student loan consolidation occurs when you have multiple loans and you merge them. Thus, instead of having multiple loans you have one big loan.  The most common student loan consolidation is a direct consolidation loan.  This is a government program that allows you to combine multiple federal student loans.

The interest rate on the one big merged loan is the weighted average of your prior loans. For example, let’s assume you have two loans.  Each loan has a balance of $10,000. One has an interest rate of 6% and the other 8%.  Your consolidated loan would have a principal balance of $20,000 with a 7% interest rate.

The key thing to understand is consolidation, by itself, neither reduces your monthly payment and doesn't save money.

Why Do People Recommend Student Loan Consolidation?

As we saw in the prior example, consolidating by itself does not provide 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 companies.

Post-graduation, many students will have anywhere from 5 to 30 different loans and they could be located at different companies.  Student loan consolidation could move them all to one company.  (Note: By companies I am referring to servicers such as Navient, Great Lakes, Nelnet, etc...)

For this reason, many “older” individuals say to consolidate your loans.  Therefore, 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.  Your friends may also be getting it confused with student loan refinancing.

Reasons Why You Wouldn’t Want to Consolidate

Now days, you do not have to worry about writing checks.  It is very easy to set up automatic payments.  Therefore, student loan consolidation simply to make life "easier" is not a reason to consolidate.  In fact, you most likely want to avoid consolidating your loans.

There are two primary reasons to avoid consolidating your loans:

1. If you are trying to save money and are making prepayments.  Student loan consolidation makes it impossible to target specific loans. 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 only have one big loan with one interest rate.

2. You may have less financial flexibility in the future. For example, assume you have two loans each with a required monthly payment 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.  This could be huge if you need financial help one day or want to buy a house.

Reasons Why You Would Want to Consolidate

There are two reasons why one would want to move forward with student loan consolidation:

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. This is a tough decision to make and why many individuals choose to work with FitBUX. We'll help you evaluate the savings and various options.

2. Depending on when your loans were disbursed, you may have to consolidate your loans to take advantage of 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.

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