When you’re approaching graduation and the prospect of repaying those loan balances – while also taking full responsibility for your post-college living expenses – any way to make loan payments easier sounds really appealing.
And if you have multiple loans to keep track of, you might be asking yourself “should I consolidate my student loans?” It’s a valid question. A Direct Consolidation Loan can look like the answer to a huge problem, simplifying all your various federal loans and monthly payments into just one.
But there are drawbacks to consolidation as well, and it’s important to understand them all before making a decision. Here’s how to determine whether consolidation will actually help you after graduation.
Pros and cons of student loan consolidation
Make no mistake: debt consolidation can be beneficial for borrowers. The issue is determining whether or not consolidating is a good financial solution for your unique situation.
Benefits of student loan consolidation
Let’s start by understanding why people consolidate their federal student loans. One of the biggest reasons is the fact that consolidation simplifies your debt repayment by turning multiple loans into a single loan. This can make it easier to keep track of your debt and stay on top of payments.
Consolidation can also lower your monthly payment, though that may come with a tradeoff of a longer repayment term. This means you’ll spend more time paying off your loans – and pay more in interest over that time.
Consolidating your federal student loans is also often a step in going on an income-driven repayment plan such as Income-Based Repayment or REPAYE. If your monthly payments are unmanageable and you’d benefit from having them capped at a percentage of your income, or have already defaulted and are now rehabilitating your loans, consolidation is the way to go.
The drawbacks to consolidating after graduation
All this being said, there are significant reasons to avoid consolidating your student loans (at least immediately after graduation).
Loan consolidation and refinancing are often confused. Refinancing student loans with a private lender is generally done in order to consolidate loans into one with an overall lower interest rate. Direct Consolidation, on the other hand, does not help save money on interest because it takes a weighted average of your previous loans and tacks on a small percentage on top.
Plus, as mentioned, consolidation can result in a new, lower monthly payment that frees up some cash today – but if your consolidated loan has a longer term, you’ll lose more money in the long-run because you’ll pay more in interest.
Check out this prepayment calculator to see how paying off your loans faster saves you money.
Finally, consolidating multiple loans into one means you can no longer be strategic about how you pay them off. For instance, you could target your highest interest rates first using the debt avalanche method. Or you might choose to pay off any private loans first since they tend to have less flexible repayment options. Consolidation renders this impossible.
The pros and cons of student loan consolidation are closely interrelated. What can be an advantage in one situation (like potentially reducing your payments) can be a completely moot point in another (when your repayment term is extended).
It’s important to evaluate your own personal situation and run the numbers to see what strategy puts you ahead financially. Fee-only financial planners who specialize in working with Gen X and Gen Y and helping with student loan issues can be great resources in getting this question answered.
So should I consolidate my student loans?
If you’re asking, “should I consolidate my student loans?” the answer for most borrowers is probably not. This is especially true if you’re not having trouble making your payments and you can target your repayment efforts to specific loans.
Sophia Bera, a financial planner and founder of Gen Y Planning, agreed that it doesn’t usually make sense for borrowers who just graduated to consolidate their loans. “Your interests rates are averaged and then they round up. Therefore, it’s more expensive to pay off your loans this way,” she said.
Bera added that because most people’s loans all have different interest rates and balances, paying off loans in order from highest interest rate to lowest is the best way to save the most money.
Avoiding consolidation allows you to get strategic with your debt repayment. You can evaluate both your financial situation and your own personality to determine what the best method of debt paydown is for you.
The point is that by not consolidating immediately after graduation, you keep your options open. Remember that other strategies include looking into repayment programs for your eligible Federal loans.
In the long run, the best method of repayment is the one that keeps you on track and continuously taking action until you’re debt-free.
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