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Tips On Consolidating Student Loans
David K. Randall, 04.15.09, 06:00 PM EDT
Student-loan consolidation has its benefits, but it's not for everyone.
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 ( WFC - news - people ), 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.
Steer clear of any lender that charges a prepayment fee. You'll want the option to pay off the loan early without being penalized for it.
Student Loan Consolidation
A separate page provides a comparison chart of consolidation loan discounts.
Most FFELP lenders are no longer offering consolidation loans because these loans are no longer profitable. Students can still consolidate their loans with the US Department of Education's Federal Direct Loan Consolidation program at loanconsolidation.ed.gov even if their college does not participate in the Direct Loan Program.
The interest rate on a consolidation loan is the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest 1/8 of a percent and capped at 8.25%.
For example, suppose a student has just unsubsidized Stafford Loans originated on or after July 1, 2006. These loans have a fixed interest rate of 6.8%. When they are consolidated by themselves, the consolidation loan will have an interest rate of 6 and 7/8ths of a percent, or 6.875%. So the interest rate increases only slightly.
If the borrower has a mix of loans with different interest rates, the weighted average will be somewhere in between. For example, if the borrower has $5,000 of Perkins Loans (at 5.0%) and $10,000 of unsubsidized Stafford Loans (at 6.8%), the weighted average is
$5,000 * 5.0% + $10,000 * 6.8%
------------------------------ = 6.2%
$5,000 + $10,000
This weighted average, 6.2%, is then rounded up to the nearest 1/8th of a percent, yielding a consolidation loan interest rate of 6.25%.
Note that the weighted average does not fundamentally alter the underlying cost of the loan. It preserves the cost structure by including each interest rate to the extent that it applies to part of the overall loan balance. For example, the consolidation loan in the previous paragraph says that of the $15,000 consolidation loan balance, $5,000 will be at 5.0% and $10,000 at 6.8%, yielding an equivalent interest rate of 6.2%.
If you are consolidating loans with different interest rates, the weighted average interest rate will always be in between. Don't be fooled if someone tries to suggest that this will save you money by getting you a lower interest rate. The interest rate may be lower than the highest of your interest rates, but it is also higher than the lowest of your interest rates. More importantly, the amount of interest you pay over the lifetime of the loan will be about the same.
(For the mathematically inclined, there is a slight difference due to the different shapes of amortization curves at each interest rate. In the example given above on a 10 year term, $10,000 at 6.8% has a monthly payment of $115.08 and total interest paid of $3,809.66, $5,000 at 5.0% has a monthly payment of $53.03 and total interest paid of $1,364.03. If you add these, you obtain a total monthly payment of $168.11 and a total interest paid of $5,173.69. Using the weighted average, $15,000 at 6.2% has a monthly payment of $168.04 and a total interest paid of $5,165.01. So using a weighted average yields a very small reduction in the monthly payment (in this case, 7 cents) and in the total interest paid ($8.68) due to a kind of triangle law. Of course, when you consolidate the interest rate is rounded up to the nearest 1/8th of a point, so $15,000 at 6.25% has monthly payments of $168.42 and total interest of $5,210.42, yielding a slight increase. So you pay a tiny bit of a premium for consolidation, due to the rounding up of the interest rate.
The PLUS loan interest rate loophole can reduce the interest rate on 8.5% fixed rate PLUS loans by 0.25% through consolidation.
If you were deferring the interest on an unsubsidized Stafford Loan by capitalizing it, most lenders will add the capitalized interest to principal when you consolidate. (Lenders can capitalize interest at most quarterly, but most capitalize it once when the loans enter repayment or at other loan status changes.)
No Cost to Consolidate
Aside from a slight increase in the interest rate on the consolidation loan, there is no cost to consolidate your loans. There are no fees to consolidate.
Under no circumstances pay a fee in advance to get a federal education loan or consolidate your federal education loans. There are no fees to consolidate your loans. While other federal education loans, such as the Stafford and PLUS loans, may charge some fees, the fees are always deducted from the disbursement check. There is never an up front fee. If someone wants you to pay an up front fee, chances are that it is an example of an advance fee loan scam.
Who Can Consolidate
Both student and parent borrowers can consolidate their education loans. (Students and parents cannot combine their loans through consolidation, since only loans from the same borrower can be consolidated. But they can consolidate their loans separately.)
Married students are no longer able to consolidate their loans together. This provision was repealed effective July 1, 2006. When married students consolidated their loans together, each spouse became responsible for the full amount of the loan, and the loans could not be separated if the couple got divorced. To avoid such problems in the future, Congress decided to repeal this provision as part of the Higher Education Reconciliation Act of 2005.
Students can only consolidate their education loans during the grace period or after the loans enter repayment. (Loans that are in default but with satisfactory repayment arrangements may also be consolidated.) Students can no longer consolidate while they are still in school. (The early repayment status loophole and the ability of Direct Loan borrowers to consolidate during the in-school period was repealed as part of the Higher Education Reconciliation Act of 2005, effective July 1, 2006.)
Parents, however, can consolidate PLUS loans at any time.
You Can Consolidate with Any Lender
Students and parents can consolidate their loans with any lender, even if all of their loans are with a single lender. (The single holder rule was repealed on June 15, 2006, as part of the Emergency Supplemental Appropriations Act of 2006. Borrowers no longer need to exploit the single holder rule loopholes in order to consolidate with any lender.) Direct Loans can also be consolidated with any lender. This allows you to shop around for a lender that offers a lower rate or better discounts.
Most lenders require a minimum balance before they will consolidate your loans. For example, many lenders will only offer consolidation loans for borrowers with loan balances of at least $7,500. A few lenders will offer consolidation loans for balances of $5,000 or more, and the Federal Direct Consolidation Loan program has no minimum balance for consolidation loans. (Lenders may not discriminate against borrowers who seek consolidation loans on the basis of number/type of student loans, type/category of educational institution, the interest rate on the loans, or the type of repayment schedule sought by the borrower. Lenders are, however, able to discriminate on the basis of the amount of the loans being consolidated, so lenders can set a minimum balance on the loans.)
Which Loans Can be Consolidated?
Any federal education loan can be consolidated. You can even consolidate a single loan. There are, however, a few restrictions on consolidating a consolidation loan.
You can consolidate a consolidation loan only once. In order to reconsolidate an existing consolidation loan, you must add loans that were not previously consolidated to the consolidation loan. You can also consolidate two consolidation loans together. But you cannot consolidate a single consolidation loan by itself. These restrictions have been in effect since early 2006.
Note that when you reconsolidate a consolidation loan, it does not relock the rates on the consolidation loan. The consolidation loan is treated as a fixed rate loan within the weighted average interest rate formula used to calculate the interest rate on the new consolidation loan. Consolidation does not pierce the veil on previous consolidations.
The new restrictions on consolidating a consolidation loan limit your ability to use consolidation to switch lenders. Generally, you will consolidate your loans once, toward the end of the grace period or after the loans enter repayment, and then be locked into that lender for the lifetime of the loan. If you want to preserve your ability to use consolidation in the future to switch lenders, you should exclude one of your loans from the consolidation.
Consolidation loans provide access to several alternate repayment plans besides standard ten-year repayment. These include extended repayment, graduated repayment, income contingent repayment (Direct Loans only) and income sensitive repayment (FFEL only). If you do not specify the repayment terms, you will receive standard ten-year repayment.
Consolidation loans often reduce the size of the monthly payment by extending the term of the loan beyond the 10-year repayment plan that is standard with federal loans. Depending on the loan amount, the term of the loan can be extended from 12 to 30 years. The reduced monthly payment may make the loan easier to repay for some borrowers. However, by extending the term of a loan the total amount of interest paid over the lifetime of the loan is increased.
In certain circumstances (for example, when one or more of the loans was being repaid in less than 10 years because of minimum payment requirements), a consolidation loan may decrease the monthly payment without extending the overall loan term beyond 10 years. In effect, the shorter-term loan is being extended to 10 years. The total amount of interest paid will increase unless you continue to make the same monthly payment as before, in which case the total amount of interest paid will decrease.
You do not need to pick an alternate repayment plan. We recommend sticking with standard ten-year repayment, because it will save you money. The alternate repayment plans may have lower monthly payments, but this increases the term of the loan and the total interest paid over the lifetime of the loan. See our caveat about extended repayment below.
Repayment on a consolidation loan will begin within 60 days of disbursement of the loan, unless the borrower qualifies for an deferment or forbearance.
Federal education loans, including consolidation loans, do not have a prepayment penalty. So you can pay off all or part of your federal education loans without incurring a penalty. If you want to take advantage of this, be sure to include a letter with the extra payment indicating that it should be applied to reducing your principal. Otherwise, the lender may treat it as an advance payment of the next month's monthly payment.
Tools for Evaluating Consolidation Options
FinAid's Loan Consolidation Calculator can help you understand the tradeoffs of consolidating your loans. It compares the reduction in the monthly loan payment with the increase in the total interest paid over the lifetime of the loan. It also shows you the interest rate on your consolidation loan.
Despite the switch to fixed interest rates on Stafford and PLUS loans eliminating a key financial incentive to consolidate, there are still several reasons to consolidate your education loans. These include having a single monthly payment, access to alternate repayment plans, the PLUS loan interest rate loophole, and the ability to reset the 3-year clock on deferments and forbearances. But consolidation can cut short the grace period, although the grace period loophole can work around this problem. It is best to avoid consolidating Perkins loans, because you lose several valuable benefits. Beware of extending the term of your loan, as this can increase the total interest paid over the lifetime of the loan; you can stick with standard ten-year repayment.
Before consolidating, always evaluate the benefits provided by the current holder of your loans. The loan discounts offered by originating lenders tend to be superior to those offered by consolidating lenders, since consolidation loans have tighter margins. Also, if you received a fee waiver or rebate from the originating lender, you may have to repay that discount if you consolidate with another lender. It may be possible to get some of the benefits of alternate repayment plans without consolidating, such as extended/graduated repayment with a loan term of up to 25 years and a single monthly payment, if you have more than $30,000 in federal education loan debt accumulated since October 7, 1998 with the lender. (This is due to a little known provision of the Higher Education Act, in section 428(b)(9)(A)(iv), and the regulations at 34 CFR 682.209(a)(6)(ix).)
You can change the repayment schedule on your loan once per year. So consider starting off with standard ten-year repayment on your consolidation loan. You are not required to start off with extended repayment. If you find it difficult to afford the payments, you can always switch to extended repayment later.
For More Information
FinAid has a page of common questions about consolidation.
The numerous student loan loopholes are discussed in depth in other sections of the FinAid site.
FinAid also maintains a list of education lenders who offer federal and private student loans, including consolidation loans.
If your school participates in Direct Lending, you should visit the US Department of Education's Federal Direct Consolidation Loan web site.
A Direct Consolidation Loan allows a borrower to consolidate (combine) multiple federal student loans into one loan. The result is a single monthly payment instead of multiple monthly payments.
Make sure to carefully consider whether loan consolidation is the best option for you. While loan consolidation can simplify loan repayment and lower your monthly payment, it also can significantly increase the total cost of repaying your loans. Consolidation offers lower monthly payments by giving you up to 30 years to repay your loans. But, if you increase the length of your repayment period, you'll also make more payments and pay more in interest than you would otherwise. In fact, in some situations, consolidation can double your total interest expense. If you don't need monthly payment relief, you should compare the cost of repaying your unconsolidated loans against the cost of repaying a consolidation loan.
You also should take into account the impact of losing any borrower benefits offered under repayment plans for the original loans. Borrower benefits from your original loan, which may include interest rate discounts, principal rebates, or some loan cancellation benefits, can significantly reduce the cost of repaying your loans. You may lose those benefits if you consolidate.
Once your loans are combined into a Direct Consolidation Loan, they cannot be removed. That's because the loans that were consolidated have been paid off and no longer exist. Take the time to study the pros and cons of consolidation before you submit your application.
For additional information, you can view the Checklist Tool for Consolidation or visit www.loanconsolidation.ed.gov.
What kinds of loans can be consolidated?
Most federal student loans are eligible for consolidation, including subsidized and unsubsidized Direct and FFEL Stafford Loans, Direct and FFEL PLUS Loans, Supplemental Loans for Students (SLS), Federal Perkins Loans, Federal Nursing Loans, Health Education Assistance Loans, and some existing consolidation loans. Private education loans are not eligible for consolidation. If you are in default, you must meet certain requirements before you can consolidate your loans.
Note: A PLUS Loan made to the parent of a dependent student cannot be transferred to the student. Therefore, a student who is applying for loan consolidation cannot include his or her parent’s PLUS Loan.
For a complete list of the federal student loans that can be consolidated, contact the Direct Loan Origination Center's Consolidation Department by calling 1-800-557-7392 or visit www.loanconsolidation.ed.gov. TTY users may call 1-800-557-7395.
Note: Before July 1, 2010, Stafford, PLUS, and Consolidation Loans were also made by private lenders under the Federal Family Education Loan (FFELSM) Program. As a result of recent legislation, no further loans will be made under the FFEL Program beginning July 1, 2010. All new Stafford, PLUS, and Consolidation Loans will come directly from the U.S. Department of Education under the Direct Loan Program.
When can I consolidate my loans?
Generally, you are eligible to consolidate after you graduate, leave school, or drop below half-time enrollment.
What are the requirements to consolidate a loan?
To qualify for a Direct Consolidation Loan:
You must have at least one Direct Loan or Federal Family Education Loan (FFEL) that is in grace or repayment.
You can consolidate most defaulted education loans if you make satisfactory repayment arrangements with the current loan servicer(s) or agree to repay your new Direct Consolidation Loan under the Income Contingent Repayment Plan or the Income Based Repayment Plan.
If you have a Direct Consolidation Loan, you cannot consolidate again unless you include an additional FFEL or Direct Loan. If you have a FFEL Consolidation Loan you also may be able to consolidate again under certain circumstances. For additional details, go to www.loanconsolidation.ed.gov.
If you consolidate your loans, you do not need to pay any application fees and you will not be charged any prepayment penalties.
What is the interest rate?
A Direct Consolidation Loan has a fixed interest rate for the life of the loan. The fixed rate is based on the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest one-eighth of 1% and cannot exceed 8.25%.
How do I apply for a Direct Consolidation Loan?
There are several ways that you can apply for a Direct Consolidation Loan:
Apply online at www.loanconsolidation.ed.gov
Download a paper copy of the application and promissory note at www.loanconsolidation.ed.gov
Apply over the phone if you have all Direct Loans – 1-800-557-7392
Request an application package be mailed to you by:
Calling 1-800-557-7392 (TDD 1-800-557-7395) or 334-206-7400 (outside the USA)
When do I begin repayment?
Repayment of a Direct Consolidation Loan begins immediately upon disbursement of the loan. (Your first payment will be due within 60 days.) The payback term ranges from 10 to 30 years, depending on the amount of education debt being repaid and the repayment plan you select. Direct Consolidation Loans that include parent PLUS loans are not eligible for the Income-Based Repayment Plan. For additional details on repayment plans available for Direct Consolidation Loans, go to the Loan Consolidation Web site or check with your loan servicer.
Repayment Plans—There are several repayment plans that are designed to meet the different needs of individual borrowers. You will receive more detailed information on your repayment options when you consolidate your loan. To learn more about repayment plans, go to the Repayment Information page on this Web site.
What if I have trouble repaying the loan?
Under certain circumstances, you can receive a deferment or forbearance that allows you to temporarily stop or lower the payments on your loan. For more information, go to the Repayment Information page on this Web site.
Can my loan be cancelled (discharged)?
Yes, but only under a few circumstances. For more information, go to the Cancellation/Discharge page on this Web site.