Student Loan Consolidation
A lot of hoopla is made about student loan consolidations—too much hoopla in my opinion. Many people incorrectly think that consolidated student loans will lower the interest rates on their loans, when in fact they can actually raise them slightly—with one exception. This happens because a consolidated student loan actually just blends together the balances and rates on your existing loans, into one larger loan. In doing so, the new rate is simply the weighted average of the loans you had before, rounded up to the nearest one-eighth of a percent.
CHEAT SHEET
Your best bet for a reduction in your student loan rate is to make sure that you select a lender that offers incentives for paying your student loans on time. For example, many lenders decrease your student loan rate by .25 percent after you’ve successfully made 6 to 12 months of on-time payments or have signed up for an automatic withdrawal of your payment from your checking account.
For example, if a borrower has $10,000 in loans at 6.8 percent and $5,000 in loans at 5.4 percent, the new rate on the combined $15,000 consolidation loan would blend these two rates. How they are blended is based on the size of the individual loans prior to consolidation, known as a weighted average. In this case, the new rate would be comprised of two-thirds (the $10,000 divided by $15,000 in total loans) of 6.8 percent and one-third of 5.4 percent. This equals 6.33 percent, which then is actually rounded up to 6.375 percent, costing the student slightly more overall than before.
Why would someone bother with consolidation? There are four reasons you might want to consider a consolidation when you finally get around to paying for college:
• By consolidating your loans, a new longer loan period might be granted. Although this does not actually change your rate, it might lower your monthly payment by spreading the loan balance over a longer repayment period. Keep in mind, however, that spreading your loan over a longer period of time actually results in a greater out-of-pocket cost in the end.
• The idea of simplifying and having only one loan balance to keep track of is appealing to many borrowers. In truth, the actual slight increase that often accompanies a consolidation is a small price for some people to pay for the massive reduction in paperwork.
• Parents and students with PLUS loans might actually experience up to a .25 percent drop in rates with a student loan consolidation (the one exception I previously mentioned). Because the interest rate on a student loan consolidation is capped at a maximum of 8.25 percent, a parent or student consolidating a PLUS loan at the standard rate of 8.5 percent will save some dough. However, because the savings equates to only $25 per year for every $10,000 in unpaid balances, don’t count on your payments dropping dramatically.
• A student loan consolidation allows a borrower in default to get a fresh start on his loans. By consolidating, a borrower can clean up his credit a tad and arrange new payment terms that weren’t available under his defaulted loan.
DEFINITION
A federal student loan is considered in default after no payment has been received for 270 days. If a loan is in default, collection actions are imminent unless you contact the lender, make alternative payment arrangements, or attempt to “rehabilitate” your loan by making 9 on-time payments within a 10-month period.
The Least You Need to Know
• Federal student loans might be repaid under a variety of programs that range from 10 to 25 years and that include Level, Extended, Graduated, and income-based options.
• Students should opt for the longest repayment plan and lowest payment possible but commit themselves to paying it back more quickly than required.
• Deferments can be used to delay the repayment by up to 3 years for a variety of circumstances that include financial hardship, unemployment, and military service.
• Don’t count on student loan consolidations to save you large amounts of money because they actually can cost you a little more!
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