Pros and Cons of Consolidating Student Loans

Once you finish college, you are likely to look at all of your student loan payments and sigh: How are you supposed to keep all of them straight? And how can you afford all those monthly payments? This is when many people start weighing the pros and cons of consolidating student loans.

Among the inconveniences of student loans is that each loan that you receive for each school year is often considered a different loan — and it has to be repaid separately, with its own interest rate. When I finished my graduate degree, I had five different student loans for attendance at two different universities, with various interest rates.

On top of that, most federal student loans have 10-year repayment terms, starting from six months after you graduate from college. That means that you have various loans, and all of them have a 10-year repayment schedule. My monthly payments, all added together, ended up being right around $600 a month.

Ouch.

So I decided to consolidate my student loans. I got a lower rate and a lower payment, since my total repayment term had been extended to 25 years. Consolidation has worked well for me, and it can work well for many students, as long as you understand the risks.

Pros of Student Loan Consolidation

The biggest advantage of federal student loan consolidation is that your monthly cash flow improves immediately. My monthly payment went from almost $600 a month to $202 a month. Much more affordable for the recent graduate trying to make ends meet.

Not only do you have a smaller payment, but your interest rate is locked in. Right now, it appears that student loan interest rates could rise soon. Congress can raise these rates regularly. If you don’t consolidate, your rate is essentially variable. When you consolidate, though, you lock in your interest rate. My rate was locked in during the summer of 2005, so I was lucky to get a very low rate.

Plus, I consolidated at a time when private companies were doing it, so I was able to get a further discount for automatic payments, and another rate reduction for 36 on-time payments. I’m paying right around 2% on my consolidated student loans.

These days, you won’t get the same deal I have on my consolidation. However, we recently consolidated my husband’s loans, and the payments dropped by half, and the rate on his loans is right around 5% fixed.

It’s also worth noting that your student loan interest payments might be tax-deductible. This can reduce your tax liability. However, your student loan interest payments are tax-deductible whether you consolidate or not.

Cons of Student Loan Consolidation

As with all loans, anytime you extend the repayment term, the more you are going to pay. This is especially true if you end up with a higher interest rate than you had before. Some commenters on this blog described how they got an 8.25% interest rate (the highest possible rate for federal student loans) after consolidating their loans, and that high interest rate has made it very hard for them to make any significant progress in paying their loans off.

Moreover, even if you wind up with a lower interest rate after consolidation, if you switch to the 25-year payment schedule, you will be in debt for much longer than you would with a normal 10-year student loan repayment. In that way, debt consolidation could slow your efforts to get out of debt.

Pay Extra on Your Student Loans

One way to take the edge off the student loan consolidation is to make extra payments when you start earning more money. You have the advantage of a lower interest rate and a manageable payment. Then, when you can afford it, you can boost your efforts to repay your debt.

When you consolidate, and then make extra payments, you have the advantage of more efficiently paying down your student debt since more of your payment goes toward reducing the principal, rather than paying interest.

Another consideration, though, is what you could earn in other ways. Since my student loan interest rate is so low, I am reluctant to speed up its repayment; investing my money offers returns that beat my low, low student loan rate. I’m more inclined to focus on my husband’s student loans than my own, since he has a higher rate.

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