Student Loans: Should You Consolidate Them or Not?

College graduates in their caps and gowns.

With a son just wrapping up college, you might say that I always perk up when I hear or read news about student loans. We’ve been lucky and have not had to resort to student loans to fund his education. However, when I look at my nieces and nephew, I know they have and will graduate with debt. One of the issues that I hear being discussed within my family is whether or not it’s a good idea to consolidate their student loans. What are the rules and what is the process? What kind of loans can be consolidated?

What kind of student loans can be consolidated?
Any federal loans can be consolidated. However, federal and private student loans can’t be consolidated with each other through the federal government. If you have multiple private loans, you would need to give your private loan provider a call and see what options you have. You might find that your private lender may be more than happy to consolidate your federal loans into your private loans. However, experts will tell you that this is not a good idea at all. This is because you will lose many of your rights when you consolidate your federal loans through a private lender.

Additionally, PLUS loans that parents took out on their child’s behalf can’t be consolidated with any loans that their child took out on their own.

Is it a good idea to consolidate your student loans?
First you should consider if you will lose any rights or benefits when you consolidate your loans. You might lose loan cancellation benefits, discounted interest rates, or principal rebates. All of these could have a financial impact on the total cost of your student loans.

Now let’s assume that we’ve studied our loan agreements and still want to move forward with loan consolidation. Working at a non-profit credit counseling agency, I like to look at the math and find what’s best for consumers. So, let’s get out the calculator and experiment with some numbers.

Don’t Panic! I am going to crunch a lot of numbers and show them to you. However, you can find a very easy to use online Repayment Estimator to run the numbers for you.

For our experiment, we took out four federal student loans to get our undergraduate degree. This is a simplification to make our discussion easier to understand. In reality you could have a student loan for every semester or quarter of your education, resulting in dozens of loans if you were to pursue an advanced degree. In our experiment, we will borrow the current maximum amount allowed each year for federal student loans.

Loan Loan Amount Interest Rate
1 $5,500 4.50%
2 $6,500 3.40%
3 $7,500 3.86%
4 $7,500 4.66%
Total $27,000

Let’s see what it would cost us to pay off the individual loans over a ten year period. We will also include the figures after consolidating the four individual loans into a single loan at a weighted average interest rate that is rounded up to the nearest 1/8 of 1% (Seems overly complicated, but I don’t write the rules for consolidating federal student loans).

Here is how your weighted average is calculated:

(Amount of individual loan/Total of all loans) x interest rate of individual loan

Here is the math for our example:

Loan
1 ($5,500/$27,000) x 4.50% = 0.92%
2 ($6,500/$27,000) x 3.40% = 0.82%
3 ($7,500/$27,000) x 3.68% = 1.02%
4 ($7,500/$27,000) x 4.66% = 1.29%
Weighted Average: 4.05%
Rounded Average: 4.125%

Adding up all of the individual parts, we get 4.05%. However the federal rules state that the weighted average must be rounded up to the nearest 1/8 of 1% which would be 4.125%.

Now, let’s see how much those loans are going to cost us in the long run.

Loan Amount Payment Interest Paid Total Paid
1 $5,500 $57.00 $1,340 $6,840
2 $6,500 $63.97 $1,176 $7,676
3 $7,500 $74.80 $1,476 $8,976
4 $7,500 $78.31 $1,897 $9,397
Unconsolidated Total $27,000 $274.08 $5,889 $32,889
Consolidated Total $27,000 $274.97 $5,996 $32,996

So what are the results of our experiment? Over 10 years of payments, the consolidated loans would cost us $107 more to pay off than the individual loans. Not a big difference, but why was it more expensive? The culprit is that weighted average interest rate. It’s higher than some of the interest rates used in our original individual loans.

Clearly, in our experiment, loan consolidation will cost us a little more. However, that will not always be the case and you should do the math for your situation before you make a decision to consolidate your debt.

If there is no significant difference after consolidation, why would you want to consolidate your student loans?

One of the most common reasons for consolidating student loans is to extend the length of time you have to payoff the loan. On one hand, this will lower your monthly payment. On the other hand, by extending the life of the loan, you will end up paying more interest and the total cost of the loan will be much higher.

Let’s look at our previous experiment and extend the life of the loan from 10 years to 20 years and see what happens to our monthly payment and the total cost of the loan.

Loan Amount Payment Interest Paid Total Paid
10 Year Unconsolidated $27,000 $274.08 $5,889 $32,889
10 Year Consolidated $27,000 $274.97 $5,996 $32,996
20 Year Consolidated $27,000 $165.40 $12,696 $39,696

As we can see from the results of our second experiment, we can significantly reduce our payment to $165.40 per month. However, there is a trade off because we will pay interest over an extra ten years and the total cost of our loans will increase by $6,807. You will need to look at your monthly budget and determine if you really need the lower monthly payment. If not, stick with the shorter loan and you will save a lot of money over the length of the loan.

Some people might save money if they have older variable rate student loans that were taken on prior to 2006. Consolidating them into a current fixed rate loan could reduce their interest rate and in turn reduce their payments as well as the cost of the loan.

Another reason is to make your life easier. This may not be needed as much as in the past. However by consolidating your loans, you will write only one check every month instead of one for each of your individual unconsolidated loans. For many people, the simplicity of managing a single consolidated loan helps to ensure they make their full monthly payment on time. Imagine writing dozens of checks each month with varying due dates. You have to weigh the cost verses the convenience and simplicity.

One last argument for consolidating your federal student loans is that you may gain access to additional repayment options like the Income-Based Repayment Plan, Pay As You Earn Repayment Plan, or the Income-Contingent Repayment Plan.

How do you go about consolidating your student loans?
Right off the bat, I want to say that you should not use one of the debt consolidation companies that advertise all over the internet. They just want you to pay them to consolidate your loans when you can do it yourself for free.

Federal student loans can be conveniently consolidated online at: www.studentloans.gov. The federal Direct Loan Consolidation Program allows your to consolidate virtually any federal student loan including subsidized and unsubsidized Stafford loans, PLUS loans, Direct loans, Perkins loans, and many more.

If you have private student loans, reach out to your private loan provider and ask them about their loan consolidation programs.

Can you reverse your student loan consolidation if you don’t like the results?
No, you can’t. After the loan consolidation process is complete, the original loans no longer exist. It’s as though they never were. The timing of your loan consolidation can be crucial because you only have one opportunity to refinance most federal student loans.

Wrapping things up:
I am sure that you will still have some questions about student loan consolidation. For more information, you should visit: https://studentaid.ed.gov/repay-loans/consolidation. There, you will find all of the detailed answers to your questions.

My next step will be to give my brother a call and let him know what I’ve learned about student loan consolidation. Being my younger brother, I might even offer to run the calculations for him. After all, I am smarter, better looking, and Mom likes me more.

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