I consolidated my undergraduate loans in 2003, which in some ways was the golden age of student loan consolidation. Back then, consolidating was a solid method for reducing interest rates, reducing monthly payments, and taking advantage of lender discounts.
Unfortunately, there have been many changes to the regulations governing student loan consolidations since then.
Consolidating my graduate debt with my remaining undergraduate loans in 2006 was much less of a financial slam-dunk, and the perks of consolidation have further eroded in the past several years. Many of the ideas about the benefits of student loan consolidation remain in place, even though they’re no longer true.
Here are two myths you may still believe about student loan consolidation:
“Consolidation will help you lock in a much lower interest rate.”
The fact of the matter is that you can no longer improve your interest rate through consolidation. As of July 1, 2006, federal education loans no longer have variable interest rates. Prior to that point, consolidation was nearly always a good idea as it could lock in a lower interest rate than you might pay on your original loan.
Now, however, federal education loans all have fixed rates, so consolidation is unnecessary in order to lock in a rate. In addition, your consolidated rate is now determined by taking the weighted average of the interest rates on the loans being consolidated and then rounding it up to the nearest 1/8 of a percent — with a cap of 8.25%. For example, if you have an unsubsidized Stafford Loan for $10,000 with a 6.8% interest rate (which is the fixed rate for those loans) and a Perkins Loan for $5,000 with a 5% interest rate, your weighted average is 6.2%
This average rate would then be rounded up to the nearest 1/8 of a percent, or 6.25%. Consolidating in this way therefore does not save you money in interest, as it’s basically the same amount you would have paid had you left the two loans separate.
“Consolidating your loans means you’ll save money — now and over the life of the loan.”
This might have once been the case, but these days you’re likely to spend about the same amount or more with a consolidated loan than you would if you left them be.
Prior to 2010, lenders offering consolidation loans would sometimes offer small discounts to borrowers in order to make their particular consolidation programs attractive. That practice was becoming less common after the sub prime credit crisis, and it went away entirely as of July 1, 2010. Since that date, all new federal consolidation loans have been made through a single lender — the federal direct loan program — meaning there’s no longer any competition, or discounts, for borrowers. The only discount the federal direct loan program offers is a 0.25% interest rate reduction for paying via auto-debit.
While it’s possible to extend the term of your loan when you consolidate, thereby reducing your monthly payment, that doesn’t save you money over the life of the loan, and will, in fact, increase your interest payment over the loan’s term.
The Bottom Line
Consolidating your student loans is a good idea for the sake of money management; it provides you with a single monthly bill to pay, and it can help you to determine the monthly payment that best fits within your budget. But it’s no longer the great deal it once was, and it’s important to keep that in mind.
Have you consolidated your student loans? Why or why not?