If you are making more than one student loan payment each month for your various types of loans, you may be tempted to consolidate to get down to one payment each month. Certainly this would make it easier to keep track of your educational debt, but is this the best route for you? If you’re considering consolidating your loans, here are some downsides you should be aware of.
#1 Increased Interest Payments – When federal student loans are consolidated, the interest rates are weighted according to loan balances and then rounded up by one-eighth of a percent. What happens thus is that you will be effectively paying a lower interest rate on what were higher interest loans and vice versa. Depending on the configuration of your loans, a consolidation may make no difference or may cost you more. See the two consolidation scenarios we’ve plotted below.
Under a 10 year consolidation, the interest expense would be close, but can still cost you more while not lowering your monthly payments. But if you are taken in by the allure of a lower monthly payment and talked into a 20 year consolidation, you’ll pay drastically more in interest in the long run. And lets be honest, you can make a lot better use of the money you save than your lender can. For instance, how much better off would we be if all that extra student loan interest money went instead to charities that help those hit by disaster such as Superstorm Sandy or this week’s Boston Marathon attack.
To see how your loans would fare in a consolidation, you can compare the payment terms of each of your loans individually using this loan calculator, total them up and then compare them to this consolidation calculator to see whether it will work out in your favor.
#2 Benefits Lost – Cost of interest aside, there are other concerns you must factor in before you opt for a student loan consolidation. For instance, teachers and other school system employees eligible for Perkins loan cancellation will lose this benefit if they consolidate their Perkins loans in with other loans.
Other Perkins loan holders eligible for cancellation include nurses, law enforcement personnel, corrections officers, Peace Corps and some armed forces members would also lose out on any cancellation benefits if they rolled up their Perkins loans in a consolidation.
And very importantly, if you are eligible for public service loan forgiveness or another type of forgiveness or cancellation program, you must make 120 qualifying payments on your loans. If you consolidate mid-stream – say 40 payments into your 120 – you will start over again at one with your first payment on your newly consolidated loan. In this case, seeking income based repayment options to lower your loan payments will be more beneficial.
#3 Repayment Options Limited – We took a look last week at ways to pay down your student loans faster and for a lower overall cost by applying Dave Ramsey’s avalanche debt payment method. Under this scenario, you tackle your highest interest rate student loan first by devoting some discretionary income toward it to pay it down as fast as possible.
Once that loan is paid off, the amount of that monthly payment would be dedicated to the next highest interest rate loan. This can allow you to pay off all of your loans faster and for a lower cost. But once your loans are consolidated, this avenue is closed off to you.
Even if you devote some spare cash toward the principal, you won’t be able to pay down your loans nearly as fast or for less cost than you can with the avalanche plan. This is something to carefully consider. Also, once you consolidate loans, they can’t ever be separated again because the old loans are paid off and a new loan established.
#4 Spousal Consolidation Issues – This is another issue we addressed before, but it’s worth mentioning here. If you consolidate your student loans together with your spouse’s student loans, this can become a real mess if you ever split up. Federal loans are no longer allowed to be consolidated this way, but there are still many pre-existing consolidations that are plaguing divorced couples.
Private loans can still be consolidated jointly between spouses and this is something to think long and hard about (and then reject). No one wants to think about their marriage ending, but if it does, you will still be tethered by your student loans long after all of your other divorce issues are sorted. Once consolidated, loans are married forever, even if you’re not. There’s no way to separate them and if one party fails to pay, becomes disabled or dies, the other ex will be pursued for the entirety of the debt!
If you’re considering consolidation, don’t just say “yes” and dive in. This is a very serious and permanent decision. You should run scenarios to ensure that you won’t be worse off financially and also consider any benefits you could lose if you consolidate. For now, if you want to keep better track of all of your student loans, try Tuition.io’s free tool to manage and optimize your debt, review repayment options and contact your lenders.
If you’re interested in repayment and forgiveness options or the impact of interest rates on student loans, consider these related blogs: