Every month, a stack of student loan bills arrives in your mailbox. The monthly payments are high since you only have 10 years to pay the money back. You dream of having a little more money in your pocket each month to put towards a down-payment or start a 401K, so you consider using the student loan consolidation process. Lower monthly payments and longer loan terms seem like a deal that is just too good to pass up, but is it?
Consolidating your student loans is a huge financial decision. Like any financial decision, there are pros and cons that borrowers must consider. Lower monthly payments, one interest rate, and one monthly bill are huge benefits, but they do come with a price. That price is more interest, loss of benefits, and the possibility of additional fees. Let’s take a look at some of the biggest disadvantages of consolidating your student loans:
Minimum Student Loan Balances – The majority of student loan consolidation companies will require a minimum loan balance. It takes a lot of work to consolidate your loans. A company does not want to go through all that work for a measly $3,000. In fact, most private lenders will require a minimum balance anywhere between $5,000 and $10,000. If you don’t meet the minimum balance, you are out of luck.
Federal and Private Loans Must Be Separated – You are certain you can consolidate your loans because you have a total balance of $7,500. The balance is equally divided between private and federal loans, so there shouldn’t be a problem. However, you have a big problem. Federal and private loans must be consolidated separately, so you will need to have two different minimum balances. Federal loans are backed by the federal government, not private banks. These loans operate under a different set of laws and regulations than private loans. Technically, you will not have just one student loan bill each month. You will have two bills. One for your federal loans and one for your private loans.
Longer Terms Lead to Higher Interest Payments – If you ask most people why they want to consolidate, they will quickly say lower monthly payments. The only way you can get lower monthly payments is to extend the term of your loan out 10, 15, or even 20 years. Any time you extend the terms of your student loans, you run the risk of paying more in interest. The longer you have the loan, the more interest you end up accruing and paying. If you are close to paying off your loans, the extra interest alone should discourage you from consolidating.
One Interest Rate – Each of your student loans will have different interest rates. By consolidating all of your private loans together, you can have just one fixed (or variable) rate that is applied to your remaining loan balance. Federal loans will be given a fixed rate that cannot exceed 8.25%. However, your new consolidated interest rate will not always be beneficial. In fact, it could end up costing you much more. How? Let’s assume that you have four private loans totaling $30,000. Your largest loan is $18,000 with a rate of 5.6%. The remaining loans have rates averaging 7%. Consolidating may actually end up increasing the rate on that larger loan, making it even more expensive. Remember, you do not have to consolidate all of your loans together.
Say Goodbye to Those Special Benefits – Individual student loans can have special benefits like loan forgiveness, grace periods, and extra incentives. When you consolidate, these benefits often disappear, which can cost the borrower a bundle. Some private lenders may ask you to reimburse them for those benefits if you choose to consolidate! Pay careful attention to any loan-forgiveness benefits attached to your federal student loans. The Perkins Loan does have a provision that will forgive a portion of the loan if you are a teacher. Consolidating voids that provision.