I have student loans and I’m wondering if it’s a good idea to consolidate them. Does it ever save money to consolidate student loan debt if you can afford your payments?
– Eileen Asks
Absolutely. There are three main reasons to consolidate your loans: financial, management and suitability.
Financially. Basically, the Numbers
If there’s an opportunity to save money, then take it right? Consolidate your loan can make sense whenever you can materially save money. It takes some work, but if you can transfer your debt to another lender while paying a lower interest rate, then you are ahead. Do your homework though, and make sure that:
- You can justify the upfront cost. In many instances, there is a cost involved in starting a new loan. Most of the time, it’s money but even if there are no financial cost, carrying out this exercise takes time away from other activities and adds stress.
- You understand the new loan terms, as it compares with the old. The new loan comes with new terms, and everyone who tries to sell you a loan is a salesperson. It doesn’t matter if it’s a broker or a friend or a representative from the bank. They are salespeople, so take their advice with a grain of salt. Additionally, they will never know the intricacies of your existing terms. Maybe you have a 6% loan that will go down to 5% once you paid the first X number of payments on time. Perhaps you are getting a discount on other services because you are a customer to the company in more than one way. Perks like these is hard to explain in detail to another individual, so it’s best if you do the comparison yourself.
- Consider the entire life of the loan. Don’t look at just the amount you are paying per month. Realize that money paid now is worth more than money paid later. Also make sure that you are calculating the lifetime cost of the loan. While monthly payment is a big part of your decision, it is never the only deciding factor. How long do you have to pay? Is there a prepayment penalty? How easy is it to make the monthly payments? What happens if you are late, or *gulp* can’t pay?
I’d like to again point out that there’s the whole psychological side to repaying debt. Everyone knows a 0% balance transfer card financially makes sense. Actually, now that there are 18 month 0% transfer offers, it’s a HUGE money saver. However, if saving on interest just makes you lazy and spend more as a result, you are in effect not saving anything. When it comes to finances for some people, going strictly by the numbers can actually mean taking several steps in the wrong direction.
Then, There’s the Management Aspect
The more payments you have, the more painful it is to keep track of them all. In the ideal world, there is one account you send your savings to, and one bill per month. Consolidating all your debt can mean reducing the number of bills you are essentially paying on a regular basis, and less to keep track of. Depending on the actual number of obligations, it could mean that you have a better handle of your financial picture, which can only benefit you. It could also mean that there’s less of a chance you would forget to make your payment, triggering late fees.
When you consolidate your loan and do your homework, you may find that another loan term suits your unique situation better. You likely applied for the student loans years ago, when you had no income. Now that you have an income and have probably become more sophisticated in personal finance concepts, you may find that:
- A longer loan term may be for you. I don’t recommend doing this, because I feel that the psychological effect of being debt free far outweighs the benefit of having more money. However, you may find that you are able to generate more profits for yourself if have access to the cash than the interest you are paying. Or perhaps you are starting a new business and need more cushion on your cash flow. In these cases, you may want to extend the life of your loan through initiating a new one.
- As I mentioned earlier, some people may even benefit from a higher interest rate. Though you probably would never find anyone willing to consolidate their loan just to pay more interest, this could actually work for a great deal of people if the bigger payments motivates them to pay it off more quickly. Most people must think I’m crazy for even suggesting this, but remember, the bottom line benefit is what matters. Occasionally, it may make sense to take a step back and gather enough energy to leap forward.
Let Me Comment on Your Real Question: Whether You Should Consolidate Your Loan
At the end of the day, while saving money is what most people are concerned about, it’s the bottom line effects considering everything else that will change that are far more important. Will the reduction of bills free you to do something that can save, or better yet, make you more money? Does consolidating your total debt make your payment smaller? Or does a debt consolidation make you spend less?
These are questions that only you can answer. Everyone is different. I suggest taking the time to get to know yourself first before making any decisions on your debt. Student loans usually have very decent rates and terms, so it’s not the worst thing in the world to keep them for now while you figure out what’s best.
Whatever your decision, think it through. Make sure you clearly understand why you are doing what you plan to do, which will help relief a great deal of stress in the future.