Do you feel crushed by your student loans? Trust me; you are not alone. According to student loan expert Mark Kantrowitz, 7 in 10 seniors will graduate with an average of $37,172 of student debt in 2016. Before they even enter the workforce, they are suffocated and limited by high student loan payments.
I know all about this feeling. For the last two years, I have focused solely on my high-interest credit card debt. It is my personal goal to have all credit card debt erased by the end of this year. While I tackle one debt, another awaits. My student loan debt is around $28,000, and I have a drastic plan to pay it off in 2017.
If you are like me, the thought of paying hundreds of dollars each month on college loan repayments is an absolute nightmare. Some people who spend more money repaying their student loans than they do on groceries, utilities, and gas combined. With the fear of never-ending payments, you might have thought about consolidating your student loans.
Consolidating your student loans can be beneficial in a lot of ways, but there are also some downsides to this strategy. If you have been wondering, “Should I consolidate my student loans?” then here are some critical things you should know before actually signing the dotted line.
1. KNOW WHAT KIND OF LOANS YOU HAVE
There are many types of student loans out there, and depending on your personal situation, you could have any one of them. Here are the important ones you need to know:
FEDERAL STUDENT LOANS
Federal loans are loans that are funded by the federal government. With these types of loans, you will not have to start repaying them until you graduate, change your enrollment status to less than half-time, or leave school. They offer a fixed interest rate, and they do not require a credit check. The interest you pay on federal student loans is usually tax deductible. They offer many different repayment options with no prepayment penalty fees. These loans may be forgiven if you work in public service.
PRIVATE STUDENT LOANS
Private loans are not funded by the government and are made by a private lender such as a bank or credit union (in some cases the school). You may be required to pay back your student loans while you are still in school and they might carry variable interest rates. That means you might be offered a loan with 10%, but it can drastically increase in the future, some greater than 18%. You also might be required to have an established credit report to qualify or a cosigner. Interest may not be tax deductible like federal student loans, and they don't have nearly the same options when it comes to repayment. There also might be prepayment penalty fees, and there is also a greater chance that the lender will not offer any forgiveness programs.
DIRECT SUBSIDIZED & UNSUBSIDIZED LOANS
These are a form of federal student loans that are available to students who need help paying for higher education at a 4-year college or university, community college, or technical school. There is one difference between these two loans that I want you to be aware of. With direct subsidized loans, the U.S. Department of Educations pays the interest while you are in school at least half-time, for the first six months after you leave school or if you decide to postpone your student loan payments (deferment).
With direct unsubsidized loans, you are responsible for paying the interest during all periods of your education. If you choose not to pay the interest while you are in school or during times where you decide to defer the payments, the interest will accrue and will be added to the principle amount of your loan (capitalized).
You might be asking why this is important information to know.
If you have federal student loans, you might have benefits and protections that do not transfer to private lenders for consolidation. For example, your federal student loans can be forgiven if you work in certain types of industries. If you decide to consolidate, that benefit may no longer be available to you.
It's always important to know what you are dealing with before you make any decisions.
2. UNDERSTAND WHAT IT MEANS TO REFINANCE OR CONSOLIDATE
When you refinance or consolidate your student loans, you essentially take all of your current student loans and roll them into one large loan. Your old loans are paid off, and you continue to make payments toward your new loan. This is particularly helpful if you are juggling three different lenders and twelve different loans and are having a trouble keeping track of what amounts are due when.
When you consolidate your federal student loans, you can to do it through the Department of Education via the Direct Consolidation Loan. If you are combining your student loans for the main reason of saving on interest, this option will not help you. This consolidation loan has a fixed interest rate for the life of loan which is based on the average interest rates on the “old” loans being consolidated, rounded up to the nearest one-eighth of 1%.
If you decide to refinance your private or federal student loans with a private lender, you have the ability to refinance to a different interest rate (depending on your credit score). This works out well if you have several high-interest student loans. This can save you thousands of dollars over the life of the loan if you can refinance for a lower interest rate.
3. KNOW THE PROS & CONS
- The ability to apply one interest rate to all of your loans, even if they originally came with a variable interest rate.
- You can extend the length of your repayment period to lower your monthly payments.
- You simplify things by making one payment to one lender.
- Multiple repayment plans.
- The potential loss of valuable benefits (loan forgiveness, flexible or income-based payment options, or deferments).
- Potentially higher interest payments.
- No turning back. Once you consolidate or refinance your student loans, there is no going back.
There are some important things to note. By extending your repayment period, you lower your monthly payment now, but you will also pay more interest over the life of the loan. If you refinance your student loans with a private lender, keep in mind that the interest rate they offer depends on your credit history and score. You are not guaranteed a lower interest rate when you decide to refinance.
IS MY CREDIT SCORE AFFECTED?
It might in the beginning. Refinancing will trigger a hard inquiry on your credit report (similar to opening a credit card). This could negatively affect your score by a couple of points, and it can remain on your report for two years. Though there might be a negative impact, in the beginning, there is a tremendous opportunity to improve your credit score. You make the biggest positive impact by continuously making on-time payments. If you are struggling to make payments on time, consolidating your loans for a lower monthly payment might help. It's also important to note that opening a new account will lower your average account age, which makes up about 6-7% of your credit score.
- Related: How to Create a Plan to Pay Off Debt
4. WHEN SHOULD YOU CONSOLIDATE OR REFINANCE?
There are many reasons to consolidate or refinance your student loans.
If you are stuck paying high variable interest rates, refinancing your loans to take advantage of a lower fixed interest rate might make a lot of sense. Credible and LendKey will provide you with multiple student loan refinancing options, and they typically offer interest rates that are hard to beat. The one thing that I love about Credible and LendKey is that you can check your interest rate without impacting your credit score. They initially pull a soft credit pull and only require a hard inquiry if you are happy with their terms and decide to move forward. Filling out an application is 100% free and takes less than 5 minutes.
If you are struggling to make ends meet, extending your repayment plan can give you some temporary relief. I say “temporary” because I only recommend doing this for a limited time. You should ALWAYS begin making extra payments when you can.
Keeping your finances simple makes it easier to manage, and that's hard to do when you are juggling several lenders and loans. Things are less likely to slip through the cracks when you are making one payment to one lender.
5. KNOW WHAT TO DO NEXT
Just like any significant financial change or decision, I always recommend crunching the numbers for your particular situation. There are a lot of private lenders that have estimated repayment calculators on their website, or they might allow you to get a quote with a soft credit pull inquiry (which means your credit score won't be affected).
I also recommend calling your current loan provider and asking what benefits would be lost if you decide to refinance or consolidate your student loans.
Always be careful of scams. Steer clear of ANY company that charges a fee to consolidate your loans for you. Consolidating or refinancing your loans can be done without a fee and you should always be cautious.
If you are wanting to crunch numbers to see if consolidating or refinancing your student loans is the best option, I recommend starting with this Loan Consolidation Calculator from FinAid. It's an easy way to see what your monthly payment will be based on different repayment terms and interest paid.
Consolidating or refinancing your student loans is a huge decision that you should not take lightly. Once you consolidate or refinance your student loans, there is no turning back. Your old loans will be paid off and are gone forever. Once you have done your research, know what loans you have, and you have called your loan provider to ask any loss of benefits, then I recommend moving forward. Once you have made your decision, you can take these following steps:
- Apply for a Direct Consolidation Loan. This is done through the Department of Education, and can only be used for Federal student loans. Fill out this form, which is completely free, requires no credit checks, and takes about 30 minutes. If you need help filling out the form or have additional questions, you can call 1-800-557-7392. Make sure to read the information carefully and thoroughly understand the terms.
- If you want to refinance your student loans with a private lender, I suggest looking into Credible and LendKey first. You can refinance Private or Federal student loans, but it's important to remember that refinancing your Federal loans causes you to lose repayment assistance programs offered by the government. Make sure you call your loan provider before you make the decision to refinance.
If you have both Federal and Private student loans, I do recommend that you keep them separate. It is possible to consolidate your Federal loans using the Direct Consolidation Loan and then refinance your Private loans with a private lender, such as Credible and LendKey. Yes, you might have two different lenders, but it might be worth it if you find out that you are losing important or useful loan benefits.
Have you considered refinancing or consolidating your student loans?