Understanding Loan Consolidation: Is it the Right Move for You?
What is a consolidation loan?
A consolidation loan pays off the outstanding combined balances for one or more federal student loans and creates a new single loan with a fixed interest rate. One lender holds the loan and you make one monthly payment. The Repayment terms depend on the amount consolidated, the type of payment plan you choose, and the length of the loan term. The following information can help you decide whether loan consolidation is the right decision for you.
What loans can be consolidated?
- Stafford Loans
- PLUS Loans
- Perkins Loans
- Health Professions Student Loans (HPSL)
- Health Education Assistance Loans (HEAL)
- Nursing Student Loans (NSLP)
- National Direct Student Loans (NDSL)
- SLS Loan (formerly ALAS Loans)
- Federal Insured Student Loan (FISL)
Not sure what kind of loans you have?
Go to the National Student Loan Data System (NSLDS) at http://www.nslds.ed.gov/nslds_SA/ to confirm your federal student loans. For other loans, refer to your financial aid information or the exit interview material you received when you left school.
What are the benefits and costs of consolidating?
Benefits
- It’s easier to make one payment to a single lender.
- Consolidation loans have a fixed interest rate, calculated using the weighted-average of the interest rates of your existing loans, rounded up to the nearest 0.125%, to a maximum of 8.25%.
- A single consolidation loan monthly payment may be lower than the total of payments made on multiple loans.
- If you’re having trouble making your monthly payments, a longer loan repayment period may provide financial relief. You may extend the repayment period up to 30 years, depending on the repayment plan you choose.
- Several different repayment plans are available to accommodate differing financial circumstances.
- If defaulted loans are paid by a new consolidation loan, your credit report is updated to show a new consolidation loan that starts in good standing.
- Under the terms of the new loan, you may have the right to payment relief if it can be justified.
- There are no fees charged to consolidate your loan.
- Know your goals beforehand (e.g., fixed interest rate, smaller monthly payment, etc.), but be aware of the long-term effects. Consolidation loans are not always the best option!
- You will lose loan cancellation benefits if you include your Perkins loan in a consolidation.
- Any outstanding interest and fees will be added to the principal balance of the new consolidation loan. Thus, interest accruals on the consolidation loan may be higher than on the original loans.
- High-balance loans have a longer repayment period. While the monthly payment is lower because of the longer repayment period, you pay substantially more in total interest. Examples 1 and 2 (shown below) demonstrate how a longer repayment period affects the total amount of interest paid.
Example 1
If you have a $15,000 loan balance and a 7.1% variable interest rate, repayment for a non-consolidated loan could look something like this:
15,000 Non-consolidated loan
10-year Repayment Period Monthly Payment - $175
Total Interest Paid - $6,000* (*Amount will change with interest rate fluctuations.)
Total Paid - $21,000 |
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Meanwhile, repayment for a consolidation loan could look like either of these: |
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$15,000 Consolidation loan
15-year Repayment Period Extended Repayment - $135
Total Interest Paid - $9,500
Total Paid - $24,5000 |
$15,000 Consolidation loan
15-year Repayment Period (gradually goes up to $250)
Graduated Payment - $89 Total Interest Paid - $11,900
Total Paid - $26,900 |
Example 2
If you have a $60 ,000 loan balance and at a 7.1% weighted-average interest rate, repayment for a non-consolidated loan could look something like this:
$60,000 Non-consolidated loan Monthly Payment - $700
Total Interest Paid - $24,000
Total Paid - $84,000 |
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Repayment for a consolidation loan could be: |
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$60,000 Consolidation loan
30-year Repayment Period Monthly Payment - $400
Total Interest Paid - $85,500
Total Paid - $145,500
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Compare the differences in the total paid!
How can I be a savvy consolidation loan borrower?
Things to consider before you consolidate:
- Consider your goals and your ability to make the required monthly payments. If repayment is affordable without consolidating, then a consolidation loan may not be your best option. However, if you simply cannot make the payment under a 10-year repayment plan, and consolidating helps you to better manage repayment, then consolidation may be a better option.
- Be wary of unsolicited loan consolidation material from companies with names similar to a federal entity (e.g. Federal, U.S., etc.). Firms may solicit your consolidation business through calls, the Internet, and the mail using confusing or misleading claims that apply to a very small percentage of borrowers.
- In many instances, a marketer may contact you about consolidating. Be sure to ask whom the lender is, who the servicer will be, and how long you have to cancel the consolidation application.
- Shop around between lenders to determine if you qualify for possible incentives, e.g., interest rate reductions for making payments electronically or for making a certain number of payments on time.
- Do your homework before you commit yourself! You decide which lender to consolidate with—but you do NOT decide whether that lender keeps or sells the loan. Ask the lender if they keep the loans and whether another company services the loans for them.
- DON’T give personal information when you get a telephone call from a consolidator. They may use that information to complete a loan application with it. Instead, RESEARCH several consolidation lenders, then initiate the call to the lender you choose.
- DON’T consolidate your federal and private loans together into a private loan because you may lose some of the benefits of your federal student loans, e.g., grace periods, subsidies, deferments and possibly other benefits.
- Be sure you are talking with the lender you chose.
- Be informed about consolidation incentives, e.g., discounted interest rate for consistent on-time payments or for electronic payments, vary depending on your specific loan program and lender.
- Be aware that incentives offered by consolidation lenders are not necessarily permanent and may not transfer if the loan is sold.
- And remember that once you consolidate, your options for re-consolidation are limited.
- MAKE SURE you only apply to one consolidation lender. If you are not happy with the way your consolidation loan is being processed, contact the lender by phone immediately, record the name of the person you spoke with and ask that they note that you want to cancel the consolidation in their records, and then, follow up in writing. Before your consolidation loan is completed, you may be able to cancel your application and apply to another lender.
- Don’t click on a lender's link before you know what it does. Sometimes clicking on a link constitutes approval to consolidate loans!
- CAREFULLY read the entire application & promissory note before signing anything.
- Read lender website information VERY carefully, especially the Borrower’s Rights and Responsibilities.
- Again, if you do change your mind, immediately notify the lender by phone AND IN WRITING that you do not wish to consolidate. You cannot undo a consolidation loan, except in very rare circumstances.
- You may add more federal FFEL or Direct student loans to your consolidation loan simply by contacting your consolidator within the first 180 days after the consolidation loan is made. Afterwards, you would have to apply for a new consolidation loan in order to add loans to an existing consolidation loan.
- If you are unhappy with your lender, you cannot ask that the loan be transferred.
- Keep copies of all correspondence or documentation related to your student loan.
- Make sure that you notify your consolidation lender of any change in your address or name.
- Be proactive! Take control of your loan situation, keep in touch with your lender/servicer; ask questions, and make sure you understand what to expect.
What should you consider when consolidating during your grace period?
- If you have a variable interest rate Stafford loan and consolidate it during your grace period, the interest rate is 0.6 percent lower than if you were consolidating when in repayment.
- You should not apply for a consolidation loan too early during your six-month grace period, otherwise you will automatically lose the remainder of it because your first consolidation loan payment will be due within 60 days from the date the consolidation loan is made.
- If you are interested in obtaining a William D. Ford Direct Consolidation Loan (Direct Loans) during your grace period, Direct Loans recommends that “borrowers should wait until about half-way through the 6-month grace period before applying for a Direct Consolidation Loan” to avoid forfeiting the remaining portion of your grace period.
- If you are interested in obtaining a Federal Family Education Loan (FFEL) during your grace period, you can request a “grace hold” service that allows you to retain your grace period while obtaining the grace rate. Check with the FFEL consolidation lender you’re considering to determine if they offer such a service.
What should I consider when consolidating Perkins Loans?
Interest Rate
Perkins Loans are at a fixed interest rate of 5%. What will be the weighted average of the consolidation loan?
Interest Subsidy and Deferment Options
In general, Perkins Loans have more deferment options than you will have for a consolidation loan, and you will lose the interest subsidy if the Perkins Loan becomes part of a consolidation.
Cancellation Benefits
Any Perkins Loan cancellation or loan forgiveness benefits are lost when you consolidate.
What should I consider when consolidating a defaulted loan?
Consolidation offers a relatively easy mechanism to satisfy defaulted federal student loans, to restore eligibility for additional federal student aid if no other unresolved debts remain, and to repay a loan obligation without the pressure of being in a default status.
Prerequisites
A defaulted federal student loan may be included in a consolidation loan after you’ve made arrangements with the loan holder and made several voluntary payments. Loan holders usually require three consecutive, voluntary, and on-time payments prior to consolidation.
Additional fees
A guaranty agency may charge collection or late fees up to 18.5 percent of the outstanding loan (including the principal and interest). The fees become part of the principal for the consolidation loan. For example, a defaulted loan of $8,500, with $1,500 of accrued interest = $10,000. Fees of $1,850 can be added to the $10,000, which means the consolidation loan will be made for $11,850.
How do I consolidate my federal student loans?
Contact any commercial FFEL lender or the William D. Ford Direct Consolidation Loan Program about consolidating your loans.
