Consolidation Pros and Cons

Dear K.G.:

Congratulations on your diploma and for not automatically buying into the consolidation hype without asking some questions first! Let’s talk about how consolidation works, and then we’ll get into the pros and cons.

When you consolidate your student loans, the lender you choose pays off your individual loans to their perspective holders, creating one new loan. The terms for this new loan are generally between 12 and 30 years longer than the 10-year term on your current loans. By having longer to pay the loan off, you end up with a lower monthly payment amount

The interest rate on a consolidation loan is determined by taking the weighted average of your current loans’ interest rates and rounding up to the nearest 1/8th of a percent. This interest rate is fixed, which means it will not change throughout the life of the loan, whereas your current loans are variable, which means they either increase or decrease on an annual basis. 

Interest rates on older student loans are adjusted every July 1 based on the 91-day Treasury bill. Loans made in the last few years are set at a fixed rate already.

Pros: Federal student loans have variable interest rates that are capped at 8.25%, with the exception of Consolidation loans, Perkins loans, and a few others. This means that depending on how the economy is doing, your interest rate can change every year and could go as high as the 8.25%. By consolidating, you ensure that for however long it takes you to pay it off, the rate will never change. 

This means that if student loan interest rates go up over the next few years, you will save money in interest. The other benefit of consolidation is that you will only need to send one payment to one company each month. Finally, the act of consolidating will not affect your credit rating.

Cons: By extending your loan payment terms, you are potentially increasing the total amount you pay back. You only get charged interest on your outstanding balance, so the longer you take to pay, the more you end up paying. This principle is the same for almost every type of consumer loan, including credit cards, car loans, etc. There’s also a chance you may lose eligibility for some benefits and loan forgiveness options that are available to you on your current loans.

The bottom line is that consolidating can be a gamble. You may want to first check with your current loan holders to find out about any loan cancellation, forgiveness, or other options you may lose if you consolidate. If you do consolidate, you should try to continue making the same monthly payment amount that you make now. This way, you can lock in the lower interest rate without running the risk of counteracting its benefits by taking longer to pay.

Regards,