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You’ve probably heard the good news—the interest on federal student
loans has dropped to the lowest rate since the beginning of the federal loan program
(3.42 for those who are repaying, and a low 2.8 if you’re in your six-month
grace period). This makes it a great time to consider turning in those multiple, high-interest
loans and consolidating them into one loan with a new low interest rate. Before
you consolidate, let’s take a look at what the process involves and how
it can benefit you (and your wallet!).
First, it is important to have a clear understanding of what loan consolidation
really means. When you consolidate your loans, your original loans are paid back
in full, and a brand new loan with entirely new terms is created for the new combined
balance. So instead of having several loans with difference balances on each—and
different variable interest rates that can fluctuate from year to year—you
are left with one loan with one fixed interest rate that always stays the same.
How is this new fixed interest rate determined, you ask? It is actually based
on a weighted average of the interest rates on your old loans, rounded up the
nearest eighth of a percent.
In general, people like to consolidate their loans for two big reasons: To lower
their monthly payments and to lock in a lower interest rate over the life of their
loan. Contrary to the multitude of spam from loan providers you find in your e-mail
inbox, however, the decision to consolidate your loans is not a one-size-fits-all
situation, since there are numerous factors unique to your situation can affect
the outcome.
Considering your unique circumstances
If you’re thinking of consolidation, it’s important to first consider
what type of loans you have. Outstanding Perkins and subsidized Stafford loans,
for example, that are awarded to students with financial need, have certain benefits
that affect the desirability of consolidation. For such loans, the government
pays the interest while you are in school; therefore, if you consolidate Perkins
or subsidized Stafford loan, you will lose that option. This means that if you
ever decide to go back to school (such as for graduate school), you can no longer
take advantage of that benefit once you’ve consolidated. Similarly, if you
have other loans with certain unique benefits, you will waive those benefits by
consolidating.
You should also consider the various balances on your loans. If, for example,
you have a few different loans and at least one of them has a relatively low balance
but high interest rate, you might be better off not consolidating and simply paying
off the balance in a timely way from your personal savings. That way, the high
interest rate loan will be excluded from the weighted average formula that determines
your fixed interest rate after consolidation.
Various other benefits that are offered from lenders to borrowers—such as
interest rate reductions for a long history of consecutive payments—may
also be waived by consolidation. (You should check with your lender first to see
if these kinds of incentives are offered to borrowers).
People who make especially good candidates for student loan consolidation are:
- Those with a large amount of debt who are struggling to meet monthly payments
and would like to lower them.
- Students who are in their six-month grace period after graduation who can lock
in a rate 0.6 percent lower than other borrowers (2.82 percent for a Stafford
loan).
- Borrowers who want to lock in a low fixed interest rate and who have the income
and savings to pay more than the minimum monthly payment (so as to avoid extending
their loan repayment term).
Keep in mind that even if you decide not to consolidate, you’ll still save
money with the lower rates, but you’ll risk paying more when rates rise
again. And finally, you can only consolidate once. Unlike the process of refinancing,
consolidation enables you to trade all your loans for one brand new loan…a
process you can only go through once. And with the rates being the lowest of all
time, why not do it now?
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