Consolidating College Loans
The concept of student loan consolidation is simple: you
apply for one large loan which will be used to pay off all your existing
student loans. That single loan will be easier to manage, because you’ll only
make one monthly payment, and because it has a longer term than your old loans
that payment will be smaller than the sum of your current payments. However,
debt consolidation is sometimes a tradeoff, an exchange of easier payment terms
for a more expensive loan, since you may pay more interest on the same sum over
a longer period of time.
The ideal consolidation loan would be one in which you took
advantage of a financial trend to secure a lower interest rate, or were able to
do so because of your excellent payment history, without extending the term of
any existing loan. However, if your choice lies between consolidating existing
loans while paying more interest over time and falling behind in your
individual loan payments, you should take the consolidation loan.
It seemed like Monopoly money to her. Emily, a New York
University senior who prefers not to use her last name, took on thousands of
dollars of student-loan debt without giving it much thought–until now. Just
weeks from graduation, she is applying for paralegal jobs in a tough market and
suddenly coming face-to-face with the fact that in six months, she’ll have to
start making monthly payments of around $250 on her $20,000 debt.
“All I had to do was sign on to the Sallie Mae Web site,
check off a few boxes and wait for the money to be disbursed,” she says. “The
thought of repaying it never really hits you until graduation is near.”
If only the task of repaying student loans was as easy as
taking them out. Instead, it’s a complex process with which millions of college
grads must grapple. Two out of every three undergraduates walk off the
graduation stage with some form of student debt, according to a 2008 College
Board study. The average: $22,700 per graduate–and that doesn’t count the
student-loan debt incurred by the half of entering college students who never
earn a degree.
With three federal loans and seven private ones, Emily is in
a situation familiar to college seniors and recent graduates across the nation.
Like her, many consider consolidating their loans as a way to lower their
monthly payments and simplify their finances. The theory is that, either by
stretching out repayment of the loans or refinancing them at lower interest
rates, the borrower can reduce monthly payments. Unfortunately, it’s not a
strategy that works for everyone.
One problem for people like Emily is that federal loans
cannot be consolidated with private ones. Another is that beginning in July
2006, all federal student loans began carrying fixed interest rates. Before
then, federal loans were issued with variable rates; by consolidating them,
borrowers could often lock in a rate that was lower than what they were paying
on each loan separately.
Now, “there is no financial benefit to consolidating federal
loans, other than having a single monthly payment and access to alternative
repayment plans,” says Mark Kantrowitz, publisher of FinAid, a Web site that
tracks the college financial aid industry.
If you can afford to make the payments on your loans,
Kantrowitz says, consolidation isn’t going to help you. If, on the other hand,
you are having trouble making your monthly payments or think that you will in
the future, consolidation can present several alternatives.
Remember, though, that while practically all repayment plans
lower the monthly payments, they also add on several thousand dollars in
interest costs by stretching out the life of the loan. If, for example, you
stretch out a standard 10-year student loan to 20 years, you can cut monthly
payments by 34%, but you will end up paying double the amount of interest over
that time, Kantrowitz says.
If some or all of your loans were written before July
2006–say, in your freshman year of college if you are graduating this year–wait
until after July 1, 2009 to consolidate, Kantrowitz suggests. He predicts the
interest rate will tumble to a historic low of 2.6% from its current 4.2%. The
problem with acting too quickly? Borrowers who have already consolidated won’t
be permitted to do so again at the new rate.
Starting this July, borrowers who have federal student loans
can opt for a new income-based repayment plan. This may be a smart option for
those entering fields with relatively low salaries, like public service. Under
the plan, which is open to anyone with federal loans, the monthly payments are
capped at a certain percentage of the borrower’s income.
The rate is defined as the difference between the person’s
adjusted gross income (the amount on which you are subject to pay federal
taxes) and 150% of the federal poverty level (which comes out to $16,245 for an
unmarried person with no children, based on current rates.)
For an unmarried individual with no children and an adjusted
gross income of $40,000, monthly payments would be capped at $365. An increase
in salary would mean an increase in the monthly payment. If the full amount
borrowed is still not paid off after 25 years of these payments, the remaining
balance is forgiven.
Students who have already started repaying loans can opt for
the income-based repayment plan, but there is an important caveat: Doing so
will restart the clock and give your loan a new term of 25 additional years.
Emily, the NYU senior, like many students, had to turn to
private loans to cover what federal programs would not. Private loans, unlike
federal ones, carry variable interest rates. Consolidating them may save
students money.
If, when the borrower took out the loan, he had a limited
credit history, as most students do, three or four years of making regular
payments on a credit card or an impressive employment history can improve a
credit score by 100 points or more. That, in turn, can persuade a lender to
reduce the interested charged as a result of a loan consolidation.
“Borrowers can get a lower rate now, and their rate may not
jump as high in the future,” Kantrowitz says.
Another potential benefit of consolidating your private loan
is the removal of a co-signer, which can save a parent or relative from a
potential liability. This is possible after 24 to 48 months of making regular
payments.
If you would like to consolidate your private student loans,
you should turn to either Chase, NextStudent, Student Loan Network or Wells
Fargo , Kantrowitz suggests. All offer slightly differing terms, and all have
caps on the amount of total debt you can consolidate.
Important questions to ask a consolidator are whether it
charges origination fees, if there are prepayment penalties, what the maximum
interest rate is and what the life of the loan will be. Read the terms
carefully, and if possible, have a friend or relative do the same. If you don’t
understand something, ask the lender until you get a straight answer. After
all, you’re entering into a contract that can last as long as 30 years.
