It’s a myth that student loan consolidation will save you money. Unless your goal is to save money on your monthly payments, consolidating your student loans will generally cost more over the life of a loan.
Loan consolidation may have helped borrowers save money in the past, but the rules have changed. All consolidation does is replace several student loans with a single loan, allowing you to focus on one monthly payment and a single payoff date.
Consolidation Doesn’t Lock in Interest Rates
Federal student loans before July 1, 2006, were issued with variable interest rates, meaning that rates could go up or down depending on the economy. As such, consolidation was a good idea because it meant being able to consolidate variable-interest loans into one low-interest loan.
Since the summer of 2006, however, federal student loans have come with fixed interest rates. Consolidation is no longer used to lock in a fixed interest rate because the borrower already has a fixed rate.
Still, there is a clear advantage to consolidating student loans. You can combine multiple loans from various lenders into one consolidated loan that is serviced by a single provider. This means you only have to deal with one monthly payment. That fact alone is enough for many borrowers to consider consolidation, even if it doesn’t save them money in the long run.
Consolidation Stretches Out Payments
Most borrowers who consolidate are also looking to lower their monthly payments, not their overall loan amount, which results in an extended repayment term. While this certainly makes payments more affordable, it actually increases the amount of interest paid over the life of the loan. Essentially, you will pay more with loan consolidation than if you had kept each loan separate and continued to make those payments separately.
For example, if you have an unsubsidized Stafford loan with a 10-year repayment plan, you can consolidate the loan with a 25-year plan. You will enjoy lower monthly payments, but you’ve just added 15 years’ worth of interest on top of the amount you’ve borrowed.
To take advantage of the convenience of loan consolidation without paying more over the life of the loan, stay away from extended repayment plans. If all of your original loans came with 10-year repayment plans, consolidate them with another 10-year plan. You won’t save any money per month, but you will have a single loan payment and will stay on track to be debt-free in 10 years.
The Benefits of Keeping Loans Separate
When saving money over the life of your student debt is the overreaching goal, it’s often better not to consolidate. Keeping your loans separate in their original forms allows you to target each one individually so you can pay them off faster.
For instance, you can double up on the payments for the loan with the higher interest rate until it’s paid off and then focus on the next. Since there are no prepayment penalties on federal or private student loans, you can pay as much extra as you want whenever you get a cash windfall and can afford it. Doing this will help you save more money than if you consolidated your loans.
Consolidation Can Limit Repayment Options
In most cases, consolidating student debt gives you access to several types of repayment options that can make monthly payments more affordable. There are instances, however, where consolidation can limit these options.
Parents who have taken out a Parent PLUS loan for a child, as well as loans for their own education, should avoid consolidating these debts. Traditional student loans come with flexible repayment options, but Parent PLUS loans do not. In fact, they’re not eligible at all for income-based repayment plans, and they also come with restrictions that can negate these options for your own student loans.
In other words, if you have your own student loans and want to consolidate them with the Parent PLUS loan you took out for your child, the Parent PLUS loan will cause your own loans to lose income-based repayment options.
Consolidation Can Affect Forgiveness Eligibility
If you’re enrolled in a student loan forgiveness program, be wary about loan consolidation. Any type of consolidation starts the clock all over again, so even if you’ve spent five years working in the public sector, which is halfway through your 10-year forgiveness period, you’ll be back to square one.
Borrowers who are several years into an income-based repayment plan, which promises to forgive the remainder of the debt after a certain amount of time, should also avoid consolidation. If you consolidate your student loans during this period, you essentially start over and lose those years in which you’ve made payments under the income-driven plan.
Consider Your Main Goal for Consolidating
To determine whether consolidation is right for you, ask yourself what your goal is. Why are you consolidating? If it’s to save money over the life of your loan, stop right there. You need to rethink your payment strategy and focus on other options to help pay your debt down quicker.
But if your goal is to create more manageable monthly payments, streamline your debts into a single loan, or begin an income-driven repayment plan, then consolidation may be the right decision. You may be able to lock in a good interest rate for the entire debt amount and stretch out your repayment plan from 10 years to 25 or more. Just be sure to consider federal consolidation options that provide flexible repayment plans, forgiveness options, and deferments.
You should also consider whether you’ll need additional student loans in the future. Remember, you can only consolidate federal loans once. If you plan to return to school, you may want to hold off until you’ve completed your education.
Loan consolidation isn’t for everyone, and it’s unlikely to save you any money over the life of your student loans. It does, however, save you money each month and comes with many other benefits that can help make managing your payments easier, so it’s a step worth considering.