Student Loan Debt Consolidation: A Good Idea?

Student loan debt consolidation can be a very effective method of lowering the total monthly payment on multiple student loans. A variety of factors will determine whether it's right for you in your particular situation.

How Does Debt Consolidation Work?

The savings generated by student loan debt consolidation is a result of taking out a new loan to pay off some or all of your existing student loans. This can result in a lower monthly payment. It's not magic, just math. If interest rates currently are lower than on your existing loans, or if you extend the time in which you are repaying the loans, it can result in a lower payment.

Two Kinds of Student Loans

Student loans come in two forms, and this can affect your ability to consolidate: federal and private.

Many of the most familiar types of student loans are backed by the Federal government. These include well-known programs such as Stafford Loans and the PLUS program, which stands for Parent Loan for Undergraduate Students. But there are many more. The loans are either offered by a federal agency, or are federally-backed and offered through commercial lenders.

Private loans also are available through most banks and credit unions. These are similar to a car loan or any other consumer loan. They are not federally-backed and are not subsidized by the government so they feature market interest rates.

Either type of loan can be consolidated, but you cannot combine government and private loans into one consolidated package.

Lower Payment not Lower Loan Amounts

It is important to understand that student loan debt consolidation can reduce your monthly payment, but it does not reduce the amount of money you borrowed. You are combining some or all of your student loans and refinancing that amount. The amount does not change.

If interest rates are lower and other loan terms are the same, you should pay less in total interest, and this can reduce the total amount of principal and interest you pay back. But remember, the loan amount remains the same.

If you extend the period in which you are repaying the loan, you might also be paying more than you originally would have for unconsolidated loans. This can occur even if the interest rate is lower.

What are the Benefits of Consolidation?

Student loan debt consolidation can be a financial management tool for you, or a financial crisis management tool. It depends on your need.

If you are facing financial difficulty with current expenses outstripping income, consolidating loans and reducing monthly payments can ease your burden. Excessive credit card debt is often handled in just this way. However, loan consolidation can be just as effective as a financial planning tool when there is no crisis. If interest rates have dropped since you took out student loans, consider comparing your payment and total loan cost from a consolidated loan with your current repayment costs on multiple loans.

Double Your Benefits

If your student loan debt consolidation frees up additional money for you monthly, plan now to take advantage of that increased cash flow in your budget. You will not only receive the benefit of lower payments, you can double the benefit by putting the additional money to work for you.

Consider reducing other debts with the extra money, such as prepaying credit card debt, a mortgage or auto loan. Be certain there are no prepayment fees or penalties as that can negate the positive impact of reducing the debt. You can also consider saving this money or, if your financial situation allows it, contributing to a tax-advantaged retirement account.

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