Consolidation vs. Non-Consolidation

Not everyone will benefit from consolidating their student loans. When people are desperate to lower their monthly payments, they often rush into this process. However, there are plenty of factors you must consider before you ever decide to consolidate. Lower monthly payments, lower interest rates, and locked-in rates are some of the benefits you can receive. Consolidating may cost you valuable grace periods, void incentives, and require you to pay even more in interest.

When you consolidate your student loans, you should be making your financial situation more manageable, not worse. Here are a few key factors that can help you decide if consolidation is the right choice for you:

Lower Monthly Payments = A Longer Repayment Period

The majority of federal and private student loans need to be repaid within ten years. Some lenders may have let you defer payment until after you graduated. Other lenders may have urged you to make interest payments while you were in school, lessening the amount you would end up owing. Now that you have graduated, you are scrambling for a way to pay back that money. Consolidating your loans will extend your repayment period, reducing your monthly payments. Based on the amount you owe, you may be able to extend your repayment period out to 25 or even 30 years.

However, student loan consolidation does come with a cost. Whenever you extend the life of a loan, you also run the risk of increasing the amount of interest you will have to pay the lender. This can add hundreds or even thousands of dollars to the amount you end up owing. The short term benefit you gain may end up costing you much more over time.

Extending your repayment period may not make much sense if you have already made significant payments to reduce your loan balance. If you have three years left to pay off the loan, is it really a smart move to extend your payment terms by another 10 years? Make sure you are extending the period for the right reasons, not because you want to reward yourself with a big vacation to Hawaii.

Interest Rate Changes

When you consolidate, you will have just one interest rate that is applied to your remaining loan balance. Most people do not have just one student loan. They have quite a few loans and each of these loans has a different interest rate. It may sound great to have just one rate to keep track of, but could end up costing you more than if you had not consolidated.

Let’s assume that you took out $3,000, $5,000, and $20,000 in private student loans. Your smaller loans carry an interest rate of 7.5% and your large loan carries a rate of 5.5%. You shop around and find that the best fixed interest rate you will receive by consolidating is 6.5%. Consolidating these loans together does not make much sense. You have reduced the interest rate on your smaller loans, but increased the rate on your larger loan by a full percentage point.

What Types of Incentives Will You Void?

Many of your student loans will have incentives and benefits tied to them. If you consolidate, you will probably void most of these extras. Check your original loan agreement to see if any of the following incentives apply to you. Then, calculate the dollar amount you stand to lose if you end up consolidating.

  • Grace Period – Most loans will have a grace period. During this period, you are not expected to make any payments. Typically, loans do not have to be repaid while you are in school. Since you cannot consolidate until after graduation, you will need to be concerned with the grace period they give you after graduation. Some loans have a grace period that varies from 60 days to 9 months. Consolidating may void this grace period, which means you have to pay the money back even quicker.
  • Loan Forgiveness – Some federal loans are eligible to be forgiven if you work in the teaching or nursing profession, law enforcement, or for The Peace Corps. Although the entire amount of the loan is not always forgiven, the savings can be significant. Before agreeing to consolidate these loans, make sure that you will not lose this benefit. Otherwise, it might end up costing you thousands of additional dollars.
  • Lose or Repay Borrower Benefits – Private lenders often provide incentives, rebates, or other benefits when you take out a student loan. One lender offers a 2% Graduation Discount, reducing your loan balance by 2% if you meet certain graduation requirements. Others may offer discounts for long-standing customers, rebates if you pay electronically, or slightly reduce your interest rate for consecutive on-time payments. These benefits are often lost when you consolidate. Some lenders may even require you to pay some of these benefits back!