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.
Suitability
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.
{ read the comments below or add one }
I’d say in 99% of the cases, consolidation of your student loans is the only way to go. However, I have seen cases of folks holding Stafford and Federal PLUS loans that include payment incentives. In some of these cases, the incentive value outweighs any interest rate reduction. Again, as you point out, it’s imperative that you sharpen your pencil, crunch the numbers and look at the bottom line. Since this is typically a one-time opportunity, you’ve got to get it right the first time. There is no second chance.
I am not sure whether to try to consolidate either. I have about 8 different loans with 2 different companies and 3 of them with the Department of Education. My concern is the impact that all of the loans have on my credit score. Would it be better to leave it alone or try to consolidate them into one. I am also still in school and am only paying on one loans as of now. I will not graduate for 6 months, but hate that these companies have multiple loans for the same schooling.
A lot of this depends on who your loans are with and how old they are. If all your loans are federally backed (i.e. stafford, perkins, FFELP etc.) and they are relatively new, (i.e. you graduated recently) then it makes sense to consolidate them all with the Department of Education. Beware, however, this process takes about three months. You may also want to look at the availability of IBR (Income Based Repayment) for your situation which will lower your monthly payment and forgive anything remaining after 25 years (assuming you are not in a public interest job which is forgiven after 10 years or 120 payments)
If you have private loans, it may not make as much sense to consolidate because you will be dealing with transfer fees and probably comparable rates.
Honestly, I think that I’d rather just pay it all off especially if I don’t have any bills or other things to pay for. <—ideal. hahah
I think the key with any consolidation is to use the benefits and time gained from the process to your advantage. Many of my clients have gotten a consolidation loan or consolidated their bills for a lower interest only to use the extra cash flow for more items and not to pay back the original debt owed. If done this way, a consolidation is terrible, both short and long term. It takes a strong willed person to not spend more money when it is available, so make sure you are ready for it and know why you are doing it.
Definitely do the homework, gather the facts, sleep on it awhile, and then make the decision. Psychologically, it may make sense not to… if you can pay one off earlier by throwing more at it, you may get that mental boost of congratulations of having paid off something 🙂
Each person is going to know themselves best, and what makes them tick – so this answer will depend on how you think and how your emotions work, as well as whether it financially makes sense.
I would say if you have several loans (which is likely for a full college career) and they are at different interest rates, then it would be best *not* to consolidate. This is because while the loans are separate you can tackle them individually (paying the minimum on the lowest interest loans while paying the most on the highest interest loan). This is of course assuming you are using direct consolidation (which only averages your current APRs), there is no incentive program to consolidate (there was an APR reduction program, but it ended long ago), and your APR is fixed.
So if you have $10,000 at 3.5% and $10,000 at 6.5%, direct consolidation will give you one $20,000 loan at 5% interest (weighed average of the two APRs). But by *not* consolidating you can focus on paying down the 6.5% interest loan first (and pay the minimum on the 3.5% APR loan). Once that portion is paid off, your remaining debt will only be accruing 3.5% annual interest.
Overall you’ll save money. Say you take 6 years to pay off your loans with either method. Consolidating you’ll have 6 years at 5% APR, not consolidating you’ll start off at an average of 5% APR but will work your way down to 3.5% APR as you pay off the higher APR loan.