Consolidating your student loans will give you one fixed interest rate. This rate will be applied to the total amount of your remaining loan balance. Federal loans already have a fixed interest rate, but you may have a mixture of these loans, so each will probably have a different fixed interest rate. Most private loans have variable interest, meaning the interest rate fluctuates at the lender’s discretion. Variable interest can be good or bad based on the current economic conditions. Most people have a number of different loans, so keeping track of 10 different interest rates can be difficult.
The student loan consolidation process does not guarantee that you will get a better interest rate. It just guarantees that you will have an interest rate that does not fluctuate. Once you sign the paperwork, your loan balance will carry this fixed interest rate throughout the life of the loan.
What to Expect
Let’s assume that you have eight different student loans that have interest rates ranging from 6.5% to 9%. Your largest loan carries the lower rate of 6.5% while you smallest loan (just $2,000) carries the higher rate of 9%. You may think that by consolidating you will automatically get your lowest interest rate or a blended average of your rates, but that is not necessarily the case.
The process for determining the new fixed interest rate for federal loans is completely different than the process used for private student loans. Once you decide to consolidate your federal loans, the consolidation company will take a look at each of your loans and come up with a weighted average of your interest rates. They will take this calculation and usually round up 0.125%. The maximum fixed interest rate you end up with cannot exceed 8.25%. The 0.125% might not seem like much to you, but remember that consolidation companies are not in this business just to help you out. They need to cover their risk and make a little profit, too. This is one way they do just that.
When you consolidate your private student loans, there is no maximum interest rate you can be assigned. Since these loans carry variable interest, the lenders could lose out big time if they were required to set certain limits. Lenders will take a look at the interest rate for each of your private loans, but they probably won’t be using a weighted average to decide your new rate. Most will use the LIBOR (London Interbank Offered Rate) to determine which fixed rate they will charge. The LIBOR is the world’s most widely-used interest rate market tool. Lenders may also take into account your credit history. If your credit has improved, they may decide to lower the rate slightly.
Each student loan consolidation company and private lender will offer different interest rates, so it is important to shop around before you begin consolidating your loans. People often think that because interest rates are capped for federal loans it doesn’t matter who you consolidate with. Thinking that way could end up costing you more money. Talk with a few companies about your situation. You will probably find out that one offers a better rate than another.
You must talk with a variety of lenders and companies when it comes to consolidating your private loans. Each will offer a different rate and different benefits for using their services. Many banks will offer interest rate discounts if you or your co-signer are a long-standing customer with great credit. They may even reduce your rate ever-so-slightly if you agree to automatic or paperless payments.
Interest rates are constantly changing, too. The figure you were quoted just two months ago could have increased or decreased by 0.50% points. Remember, once you consolidate your loans, you won’t have the chance to consolidate again. As you begin the process, start paying attention to the factors influencing the market and interest rates. A strong economy means higher interest rates, and vice versa.