Let’s face it: your diploma is probably the most expensive piece of paper you’ve ever paid for. And chances are, you took out a student loan or two to pay for it.
It’s easy when you’re in school to sign for a loan and promise to “pay it later.” It’s not always so easy, six months after you graduate, to start making those payments. All too soon it seems your grace period is over and you’re swamped with a ton of important choices. You are faced with a number of repayment options, and choosing incorrectly may cost you thousands of dollars.
One of the choices available is to consolidate your loans. Essentially, when you consolidate your loans, you take out a new loan to pay off your existing loans. Then you only have to make payments on this new, larger loan.
There are a number of reasons you might consider this option. For example, consolidating sometimes results in a lower interest rate, it reduces the number of lenders you have to pay on a monthly basis, and consolidating can lower your monthly payment amount by extending your repayment period.
However, since consolidating often extends the length of your loan (how long you will be paying it back), it can also increase the total amount you will pay for that loan over its lifetime (because you’ll also be paying interest longer), depending on interest rates.
So, you shouldn’t consolidate your loans unless you have a good reason. Personally, I needed to lower my required monthly payments; consolidating my loans allowed me to do that.
Consolidating Federal Loans
It’s important to realize that consolidating federal Stafford loans (subsidized Stafford loans and/or unsubsidized) is very different than consolidating private loans. The decision of whether or not to consolidate should be made individually for each of these types of loans.
When consolidating federal Stafford loans, you can consolidate your federal loans directly through the federal government as part of the FFEL program. They determine an interest rate by averaging out the interest rates on your current loans. There is an online calculator you can use to figure out what your payments and interest rate will be once you consolidate.
The federal government offers you terms that are comparable to the terms you have prior to consolidating; you will still have forbearance options, should you find yourself unable to make payments (forbearance is a special agreement between you and your lender, in this case the federal government, to temporarily suspend your need to make payments for a few months in the case that you are unable to make them; your interest will continue to accumulate, but you will not have to make monthly payments).
The main points to consider when trying to determine if you should consolidate federal loans are:
- Your current interest rate versus the interest rate you will have if you consolidate.
- The total amount you will pay between now and the time you will have finished paying off your loans.
- The monthly payment amount you can afford.
Consolidating Private Loans
In contrast, when it comes to consolidating private loans, there are a number of additional factors to consider. Unfortunately, the federal government will not allow you to include your private loans as part of a federal loan consolidation. This means finding a private lender who is currently accepting applications for student loan consolidations, which is increasingly difficult.
Unlike the federal government, the terms for consolidating my loans with a private lender were vastly different from my existing loan agreements.
But making the decision is similar. As with federal loans, you should compare your current interest rate with the interest rate you will pay if you consolidate (most lenders can give you an approximate interest rate over the phone if you give them information on your loans). You should also consider the difference in the total amount you will pay over the lifetime of the loan(s) and your monthly payments.
However, in addition to these points, you should also consider the following:
- What options do you have if you lose your job or find yourself unable to make your monthly payment?
- How will the new consolidated loan change your ability to deduct your interest payments from your taxes?
- What penalties, if any, are there for paying back the loan early?
Loans that are considered “education loans” have different rules than personal loans. For example, one of the benefits to paying back student loans is that, for most student loans, student loan interest payments are tax deductible. The terms for student loans also generally incorporate forbearance or reduce forbearance options, in case you find yourself unable to make your loan payments.
When you consolidate private loans through a private lender, they will often reclassify your new, consolidated loan as a “personal loan” instead of as an “education loan”–so you lose many of the benefits that come with education loans, which is very dangerous. When consolidating, it may be a good idea to consult an accountant to ensure you will still be able to deduct your interest payments from your taxes.
You should also specifically ask how much you will pay over the lifetime of the loan if you make the minimum monthly payment versus if you suddenly inherit a ton of money and pay the loan off a year from now. Typically for education loans (though you should always read through your agreement carefully), there are no penalties for early repayment–this means if you completely pay off your loans shortly after taking them out you are only responsible for the interest that has accumulated during the time you had the loan.
Sometimes, however, loan terms are such that the bank calculates how much they will make off the loan at a set interest rate over the loan’s lifetime (for example, 25 years) and if you decide to pay off your loan early, they will charge you the amount you would have paid if you had made monthly payments for 25 years, with interest.
In other words, you will be charged for 25 years of having a loan, even if you pay the loan off sooner than that.
Loan terms can be very complicated, but the most important thing to remember is to take your time, read everything completely, and ask lots of questions. Lenders would generally rather you pay them than you default; call your lenders as soon as a problem arises. Most companies are more than willing to try and help if possible, and if not, they are usually willing to offer you as much information as possible to help you make the right decision for you.