Simply put, loan consolidation is the process of taking multiple loans with varying interest rates and durations and combining them into a single one. However, consolidation is far from a guaranteed solution — you have to make sure it’s beneficial for you to take on new debt to pay off existing debt before forging ahead.
While consolidation can be a useful approach to managing your finances, it’s important to decide if you should consolidate your federal student loans before doing so.
Here’s what you need to know.
How Federal Student Loans Work
Because federal loan programs often mix and match lenders over the course of a student’s academic career, it’s fairly common to graduate owing a multiple of creditors. This means you’ll be charged with managing varying loan terms, interest rates and due dates. Keeping track of them all can be a hassle. It also introduces the possibility of overlooking one here and there, which can lead to late and/or missed payments.
Moreover, you’re automatically locked into a 10-year standard repayment plan when you graduate. This is great for getting your loans paid off as quickly as possible, but it can also mean the monthly payments are out of reach.
What Happens If You Consolidate?
The federal Direct Consolidation Loan program offers the opportunity to combine all of those loans into one at a fixed interest rate over a period of up to 30 years. Interest payments are calculated by averaging the interest rates on all of your outstanding federal loans and rounding up to the nearest eighth of a percent.
While this generally doesn’t lower your interest per se, it does keep all of your federal student loan repayment options open. What’s more, the extended repayment period can lower your monthly obligation; affording you some much needed breathing room. However, increased cost will come with that relief. You’ll pay more in interest over the life of the loan.
What Are the Advantages?
Benefits of student loan consolidation include a single (and lower) monthly payment and a fixed interest rate — as opposed to an unpredictable variable one. You’ll also get a choice of repayment plans, along with deferment and forbearance options. These can help you safeguard your credit score. You’ll also qualify for income driven repayment options, as well as Public Service Loan Forgiveness.
What Are the Disadvantages?
As we mentioned above, you might make more interest payments because of the extended loan period. The interest rate will be rounded up from your average — which could actually make it higher than what you’re currently paying.
If you were already enrolled in a forgiveness program, that time will vanish; you’ll have to start all over as of the date of the consolidation loan. Your grace period will be cut from six months down to two. Also, any outstanding interest payments due on your original loans will be rolled into their balances and become part of the principal of your consolidation loan.
The Direct Consolidation Loan program can only be applied to federal loans. If you have private student loans too, you’ll need to find another way to consolidate those. And again, you’ll only get one shot at consolidation, so you’ll have to be sure you can make it work.
So, Should You Do It?
Like so many other decisions of this nature, the key lies in determining whether the benefits outweigh the disadvantages. If you choose to move forward, the debt experts at Consolidation Plus recommend paying off the loan as quickly as your budget will allow so you can reduce the number of interest payments you’ll have to make.
You should always go for a fixed rate, rather than a variable and — above all — be certain you can make every payment on time. Taking a consolidation loan and handling it poorly can be worse than never getting one in the first place.