Consolidating your student loans may seem like a terrific idea. However, it could actually end up costing you more than if you had paid off your loans individually. One of the main benefits of student loan consolidation is extending the life of your loan. When you secured the loan, the terms most likely stated that you had 10 years to repay the money. Through consolidation, you are able to extend the life of this loan by up to 20 years.
People get very excited when they learn that there is a way to have more time to pay back their loans, but they forget one important thing. They are lured with promises that their monthly payments will be lower. Imagine how excited you would be if you learned that you could cut your $500-a-month payment in half. However, there is a cost for extending that loan. That cost is additional interest payments, which could end up adding a significant amount to your overall bill.
Potential Increased Interest Payments
Think about a monthly car-loan payment. You pay off part of the original loan, plus interest. If you decide to finance your car for a longer period of time, you end up paying more in interest charges. The same is true with student loans. When you extend the life of the loan, you also extend the amount of interest you must pay.
Federal student loans charge a fixed interest rate. This means the amount of interest you are charged will remain the same throughout the life of the loan. However, private student loans typically charge variable interest. This type of interest can vary monthly, annually, or quarterly. Consolidating your private student loans will eliminate variable interest and charge you one fixed rate for each of your loans. You may think this new fixed interest rate is an improvement, but be careful. Remember, each of your private loans will have a different interest rate structure. You may have a $15,000 loan that currently charges a rate of 4.9% and two smaller loans that charge a rate of 7.9%. Consolidating these loans together may result in a fixed rate of, say, 6.8%. It would not be a smart move to consolidate then, because you just increased the interest on your large loan by 2%.
Banks and student loan consolidation companies may charge a fee to consolidate your private student loans. These fees are often called origination fees and can range from 1% to 5% of your total private student loan portfolio. If you have a strong credit history, these fees can be quite small or non-existent. Companies may also charge a fee to manage your account. They can justify these fees because of the large amount of work involved in contacting your different lenders and monitoring your account. Some may even charge fees or penalties if you pay your loan back too early.
Companies will not charge to consolidate your federal student loans. These types of loans are governed by a completely different set of terms and regulations. Most banks no longer consolidate federal loans, so you will need to use a student loan consolidation company.
What You Need to Do Before Consolidating
Just because you can consolidate your student loans does not mean that you should. You must assess your financial situation. Review each of your loans and determine how much additional time you need to be able to pay back the money. Calculate what you think your remaining interest will be. This can be hard to calculate for loans with variable interest, so you need to look at best, average, and worst-case scenarios. Then, sit down with a bank or consolidation company, and see what they can offer and the fees they may or may not charge. Do not feel pressured to make a decision right on the spot. This is an important financial decision. You need to digest their information, measure it against your calculations, and make the right financial decision for your situation.