Student Loan Consolidation Benefits and Pitfalls
Consolidation is one of those things that you really must do your homework on before you make any decisions. It’s a complicated financial proposition, and you really should sit down with a professional (or at least a very knowledgeable friend or relative) so that you can understand exactly how consolidation will affect you.
Consolidation loans are “sold” with 2 promises, both of which are true. The problem is what you’re not told, and that’s what you need to make sure you understand. First of all, a consolidation loan does allow you to combine a bunch of loans all into one. This is part of how they’re “sold”: “Make just one payment a month! So convenient!”
That’s true. A consolidation loan tears up all of your old loans, and replaces them with one mega-loan. The new loan has all new terms and conditions (keep that in mind).
Second of all, you’re told that a consolidation loan may just save you “hundreds of dollars a month in payments!”.
That’s true, too. But here’s where the story starts to go off the rails.
You say you owe $68,000. If you leave it the way it is, or if shop it around to another lender, you’re still dealing with a debt of $68,000. So now ask yourself this – if a new lender comes along and promises you that you can pay less every month, how is this possible?
And the answer is….
You’re going to make those payments for a lot longer than you’re currently scheduled to make them now. If I owe you $100 and pay $50 a month, I’ve paid you off in 2 months. If you agree to accept $10 a month, I’ll be making payments for the next 10 months instead.
That all sounds nice, except you’re forgetting one thing. YOUR loan accrues interest. The longer it takes you to pay, the more interest accrues on the balance. There’s the really big problem with consolidation loans – you might make lower payments every month, sure, but you’ll make those lower payments for a LOT longer, and in the end, you will have paid back a LOT more money. That’s the “cost” of stretching out your repayment period.
What’s a “lot” more money? On your $68,000 loan – who knows, we could be talking about ten, twenty or thirty thousand dollars MORE.
Here’s the other problem – I referred to it earlier. Your existing loans have terms that may (or may not) be more favorable to you then the terms you can get on your new mega-loan. It’s not just what your current rate is that matters, it’s also important to keep tabs of what your ceiling is. I’m assuming that your loans have an interest rate “cap”. Moving to a new loan may bring you a higher cap, and I think it’s pretty to safe believe that interest rates are going to be heading upwards – certainly over the next 15 years or so, while you’re be paying back your loans. You need to make sure that you’re not turning loans with a 10.5% interest rate cap into a new mega-loan with a 15% cap.
Never forget that anyone who is offering to consolidate your loans is doing it for one reason only. They see an opportunity to make money. No lender is your friend – everyone of them is a business. Some of them spend an awful lot of time telling you how much they want to help you – you can trust that the relationship is actually a little more one sided in the other direction, than that.
Do your homework. If you’ve been in school a while, hopefully you’ve developed a passion for learning – apply that to learning about your financial options. For many people, consolidation is NOT a good idea. The only way to find out is to do your own research, and not listen to the siren song of the lending companies.
I hope that helped – good luck!