I recently discussed student loan consolidation and why you might want to do it. In this post I will explore some of the downsides to student loan consolidation and how to evaluate whether or not you should pursue it.
Keeping Loans Separate Can Help You
In my last post I mentioned that some students could have federal student loans with different servicers with potentially different terms and conditions. Students with loans made prior to July 1, 2006 could have loans with variable rates, adding to the confusion. Going forward, rates for new student loans will set each year in line with actual market conditions. If you choose to keep your loans separate, you can pursue a payment strategy called “payment targeting.” Let’s assume that your total monthly payment for all your student loans is $250, but you have set up your budget to allow you to make payments up to $400 per month. With payment targeting, you may choose to allocate that extra $150 to the loan in your portfolio with the highest interest rate, paying it down faster. Once that loan is paid off, you can move the payment amount and the extra $150 to your next highest interest rate loan. By paying off your highest interest rate loans first, you can save considerable money on your overall repayment plan. If you choose to pursue student loan consolidation, your interest rate will be based on the weighted rate of all your loans at the time of student loan consolidation, rounded up to the nearest 1/8th of a percentage point. In this scenario your highest interest rate loans will pull up the rate of your lowest interest rate loans, costing you more money.
Student Loan Consolidation Can Cost You Benefits
When you pursue student loan consolidation, you can include a variety of loan types. These include:
- Subsidized and Unsubsidized Stafford Loans made under the FFEL program
- Subsidized and Unsubsidized Stafford Loans made under the Federal Direct Loan Program
- Parent Loans for Undergraduates (PLUS)
- Graduate PLUS Loans
- Federal Perkins Loans
- Health Education Loans (HEAL)
While this can be helpful to you, you may lose certain benefits associated with the different loan programs. For example, the Federal Perkins Loan program offers loan forgiveness if you pursue a career in law enforcement, join the Peace Corps, or are actively deployed by the military. If you roll your Perkins loan into your student loan consolidation, you will lose the opportunity to have the loan forgiven. You may have a Parent PLUS loan as part of your student loan portfolio. If you choose to roll that into your student loan consolidation you will lose some of the flexible repayment options offered to Direct Stafford Loans or FFEL loans. If you choose to pursue student loan consolidation it is not in your interest to include these in the portfolio of consolidated loans.
Student Loan Consolidation Can Increase the Cost of Borrowing
One of the primary benefits touted about student loan consolidation is that it lowers the cost of your monthly payment by extending the term of your loan. The standard Federal Direct Loan comes with a 10 year repayment term. Paying your loan off in the standard term will cost you the least amount of money overall but with the highest monthly payment. By choosing student loan consolidation, you extend the term, which lowers the cost of your monthly payment, sometimes significantly. But, the longer term results in more interest accrual costing you more money. The chart below from the Office of Federal Student Aid, part of the Department of Education provides you with a sense of how much extending your loan repayment can cost you.
As you can see, the least amount of interest paid (and cost to the borrower) is under the 10 year standard repayment plan. If you choose to pursue the Extended Repayment plan you will save $160 in your monthly payment at the cost of over $24,000 in additional interest. Pay As You Earn looks great as most of your loan principal will be forgiven but that will only happen if your income doesn’t rise over the cost of your career. You can find repayment calculators at the Department of Education’s website.
There is much to consider before you choose to pursue student loan consolidation. If you can handle the monthly payment and coordinate payments to multiple servicers you have the opportunity to keep your cost of borrowing low. But, if you cannot make your monthly payment or keep track of multiple monthly payments, student loan consolidation can be a good, if potentially expensive, choice. Regardless of which program you choose for repayment it is always in your interest to apply any excess money you can afford against your principal payment.
Are you considering student loan consolidation? What are your questions about the program?