Student Loan Consolidation: The Good and the Bad

Last Update: February 6, 2021 • College Students • Loans • Scholarship •

Most students will graduate from college holding at least one, if not more, student loans. When it comes time to begin paying back these loans, having multiple payments due to multiple loans can be tough. It is recommended that you consider consolidating your loans into the payment to make the process easier and perhaps a little less painful.

Consolidating your student loans essentially means taking your loans and putting them into one new loan. If you successfully consolidate your loans, you will be responsible for one larger loan payment.

Consolidation is essentially a lot like refinancing a home. You come into the process with older loans, the loans are consolidated, and you come out the other side with a new loan. Rather than pay the older loan bills you had, you now pay off the newer, consolidated loan.

Should I Consolidate?

Not all loans can be consolidated. However, most federal student loans are eligible, including subsidized and unsubsidized Stafford Loans, PLUS Loans, and Perkins Loans. Federal loans in default are also eligible for consolidation, except for defaulted Direct Consolidated Loans.

Ultimately, the decision comes down to a matter of personal preference. However, consolidation is recommended in several circumstances. One big benefit to consolidation is a reduction of multiple bill payments. By combining all of your federal loans, you make one monthly payment instead of several. Yes, one monthly payment will be on a much higher balance than the individual loans you have pre-consolidated. Still, many consolidation firms will work with you in making that monthly payment one that is reasonable for your financial situation.

Another reason to look into consolidation is if you have Federal Family Education Loans (FFEL), federal loans from a bank or private lenders like Sallie Mae or Navient. You may want those federal student loans to be eligible for the Public Service Loan Forgiveness program, but only Direct Loans are eligible for this problem. Therefore, you will need to consolidate your loans into a direct loan program to qualify.

The majority of borrowers consider consolidation to lock in a fixed interest rate on their variable interest rate loans. These types of loans are ones borrowed before 2006. Because of the fluctuation in rates and the current low rates on the market, many want to take advantage of these rates and lock them in low while they can. Therefore, consolidation is an excellent option to consider.

Eligibility Requirements

You are eligible to consolidate your loans if you are not currently in school or are enrolled at less than part-time status, are currently making loan payments or are still within your loan’s “grace period,” and are not carrying at least $5,000 to $7,500 in student loans. With the costs of college rapidly increasing each year, this final requirement is usually not an issue. Lastly, you must have a good repayment history if you are currently making student loan payments, meaning you are not in default on any of your loans.

Evaluate Your Options

Do not jump in without considering all of your options and weighing the pros and cons of consolidating your loans. Several factors should play into your decision. Do you currently have the financial ability to pay the new monthly loan payment that will come from consolidation? Keep in mind that you are taking multiple, smaller loans with arguably smaller payments, and you are combining them into one larger loan. You will likely walk out with a larger payment, but it may wash out, in the end, depending on how much you are paying anyway in terms of multiple loan payments.

Also, be sure to consider the issue of prepayment penalties. Would you owe any fees if you pay the loans off early through the act of consolidation? Check with your lender before making any decisions.

Few Considerations

Several factors should be considered before applying to consolidate your loan(s). Look at the interest rate you are currently paying on your loans. Would you actually benefit from a newer interest rate on a consolidated loan? Look into whether your loans have any prepayment penalties. Investigate the terms of these, if any, and what the penalties would be concerning what you could potentially save through consolidation. Will consolidating y our loans draw out the payment period? If you add a significantly longer pay-back period to your loans, you may want to consider whether the gain is worth it. Lastly, does this fit your specific situation? Talk with a financial adviser if you are not sure. Whatever you do, please do not ask the loan consolidation place themselves. They will obviously sell you on consolidation and provide you with an answer to point you in this direction. It is best to view your options from an unbiased point of view.

Income Contingency Payments

When coming out of school, you may want a payment plan that works best with your income. Many consolidation firms will work with you to put together a payment plan with smaller monthly payments. If at any point in time, you have trouble repaying your loans or anticipate a drastic change in your financial situation, you can always consolidate to lengthen the amount of time you have to repay your loans but at a lower monthly payment.

Another option exists for those anticipating income to go up over time. Graduated payment plans allow the borrower to pay a lower monthly amount and gradually increase the repayment every couple of years.

The Disadvantages of Consolidation

Like many things in life, there are negatives to consolidation as well. To make an educated decision on consolidating your loans, a few downsides exist that you should be aware of.

By consolidating your loans, you have the option of taking longer to repay, which means the consolidation loan could cost more over time. The longer you draw out a loan period, the more interest adds up. If you are comfortable with paying extra over a longer period of time to keep your monthly payments lower, for the time being, that should not be an issue.

In some limited situations, you can consolidate while you are in school. However, by doing this, you lose the “grace period” that most loans will give you to begin paying back on loan following graduation. Many students walk out of college without a job waiting for them, so having the extra six months to earn an income to pay off the loan can help. If you consolidate during school, loan program permitting, you lose the ability to push off the start of your loan payments.

Restrictions on Consolidation

One major restriction on student loan consolidation involves private loans. Many students are forced to take out additional private loans to make up for the difference in what government loans they can get and the cost of tuition and living costs while they are obtaining their education. However, be aware that private student loans cannot be consolidated into a Direct Consolidation Loan.

Beware of Fraudulent Lenders

Not all lenders have your best interests at heart. At the end of the day, many are simply looking to make money by whatever means possible. Therefore, be aware of those lenders out there who offer you more than what is actually possible or what will actually help you. If a lender promises to lower your interest rate through consolidation dramatically, make sure that what they are promising can actually be done. In all actuality, lenders weigh the average of all of the interest rates you have on each loan and round the average up to the nearest one-eighth of a percentage. Do your homework ahead of time, so you know whether you will actually walk out with a higher interest rate than the one you were already paying on a handful of loans. If it turns out that you will be effectively paying the same after all loan rates are averaged together, it may not be worth the effort to consolidate.

If a lender charges you a fee upfront before you can even consolidate your loans, beware. Fees or expenses that come with federal loans should be taken from the actual loan check, not charged directly to the loan holders.

Another red flag should be if a lender states you, as the borrower, must choose another repayment plan for your federal loan. Borrowers with Perkins, Stafford, or PLUS loans can choose to stick with the normal 10-year repayment plan. Do not let anyone tell you otherwise, and if you find a lender doing just that, they may not be the right lender for you.