Consolidating Student Loans

Monday, June 22, 2020

Think about these five things before consolidating student loans.

The economic downturn that the COVID-19 pandemic crisis has brought on in the world and in the country is reason for financial hardship for many college students and their families.

In March, Congress passed the Coronavirus Aid, Relief, and Economic Security Act, which is known as the CARES Act. This allowed borrowers to put accounts in an automatic emergency forbearance and pause interest accrual on these loans for six months.

Not all federal student loans qualified for this support. This included older Perkins loans and certain Federal Family Education Loans, known as FFEL, held by commercial lenders. With one of these types of loans, students can gain access to emergency benefits by consolidating student loans into a federal direct consolidation loan.

What is a federal direct consolidation loan?

A new loan that allows a student to consolidate multiple federal education loans into one but does not include private education loans one may have. Both students and parent borrowers can consolidate loans, but a parent cannot consolidate a Parent PLUS loan with his or her student’s federal loans. Consolidation loans are offered at little to no cost, and it only takes half an hour to apply.

In the short term, a federal consolidation loan can help one gain access to temporary emergency benefits of 0% interest and automatic forbearance. In the long term, it can also make it easier for you to manage your federal student loan debt because you will have a single monthly payment and one student loan servicer. Monthly payment may be less because it extends the repayment period for your loan, but that can mean you will pay more over the life of the loan because of interest.

Consolidation has benefits, but it might not be the right step for everyone because every situation is different. If you’re considering a consolidation loan, you will want to make sure it is the right decision for your situation—both now and in the future—before completing the paperwork.

Think about these five possibilities before making a decision:

(1) A Federal Direct Consolidation Loan changes your interest rate.

Consolidation will establish one fixed interest rate and you will no longer be subject to interest rate fluctuations from variable rate loans.

This fixed rate is based on the weighted average of the interest rates of the loans being consolidated, rounded up to the nearest 1/8 of a percent, which could increase costs.

Use an online student loan consolidation calculator to help determine the cost of consolidating federal student loans.

If your student loans have a significantly higher interest rate, you will lose the possibility to target extra payments toward the highest-rate loans because you will only have one interest rate.

If you are able to pay more than what is due each month, paying off your highest-rate loans can save you more money because they accrue more interest than a lower-rate loan.

Ask yourself if your current financial situation is temporary and if you might want to use this strategy to pay off more costly loans first in the future.

(2) Unpaid student loan interest will capitalize, increasing the total amount owed.

When a new consolidation is taken out, unpaid interest that has accrued will capitalize and become part of the principal balance of the new loan. Once it becomes part of the new balance, students will pay interest on it until they pay off the loan.

This problem can be avoided by paying unpaid interest rate on loans before consolidating.

(3) You may lose access to certain loan-specific benefits.

Both FFEL and Perkins student loans have benefits that you may lose if you consolidate. Before consolidating, check with loan holders about whether specific benefits associated with the loan would be lost.

(4) There is a possibility that you would lose progress toward public service loan forgiveness.

Borrowers usually have different types of federal student loans, so students may have a mix of FFEL, Perkins and direct loans. If you have direct loans and have been working toward Public Service Loan Forgiveness—a program through which remaining balance is forgiven after you have made 120 qualifying monthly payments—consolidating will restart the clock. No previous payments can count toward the PSLF.

(5) There are other options.

There are benefits to consolidating student loans, but if your primary goal is to get temporary relief you should definitely check with your student loan servicer to consider options first.

With both FFEL and Perkins loans, students can suspend their monthly payments for 90 days by requesting a forbearance.

FFEL loan borrowers may be eligible for income-based repayment that could lower monthly student loan payments. This repayment plan is based on current salary and could be as low as $0 per month if your income is low enough.

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