Student loan consolidation pros and cons

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The enclosed information is not intended as legal, tax or financial planning advice.

Student loan consolidation pros and cons

This can be very attractive, particularly to those with sufficient home equity.

But before you sign on the dotted line of your new loan or refinancing agreement, make sure you know how debt reshuffling will affect your bottom line.

You can even use a consolidation loan for just one student loan. However, many financial experts strongly recommend that you consolidate your federal loans and private loans separately.

Consider the following about federal and private student loan consolidation: Federal Student Loan Consolidation The information contained herein is being provided as-is and without representation or warranty.

While a lower interest rate sounds incredibly appealing, there are definitely some downsides to refinancing.

One more thing about interest rates: Most people obsess over interest rates.

Rolling student loan debt into a mortgage (also known as “debt reshuffling”), allows you to refinance your mortgage with either a new loan or an additional home equity loan.

The money from this new loan can then be used to pay off your student loan debt.

But the more I research it now, the more I realize that I could’ve saved a few hundreds if not thousand dollars if I had decided to refinance my student loans. But not for you If you feel like your interest rates are (literally) compounding your student debt problem, you may want to consider refinancing your student loans to a lower rate.

But before you do, consider the pros and cons and refinancing.

While it is important, take a step back and look at the big picture.


Should I Consolidate My Federal Student Loans?

If you have federal student loans, you may be wondering if loan consolidation is a good idea. Often, school administrators and loan servicers push you to consolidate as soon as possible. Whether you should consolidate your federal student loans depends on a number of factors including, whether you are in default and want to get out, what types of loans you have, and whether consolidation can make your loans eligible for repayment plans that you wouldn't otherwise be able to take part in.

A consolidation loan is a loan which pays off all of your existing student loans, creating one single larger loan. The interest rate of the new loan is a weighted average of your prior loans.

Although it may seem counter intuitive, you can obtain a federal consolidation loan even if you have only one loan. In that sense, it is much like a refinance, but is still called a consolidation loan.

Any loan, public or private, can be consolidated. Federal loans are consolidated with a federal consolidation loan, which retains the repayment options provided by the Department of Education. (LINK). For federal consolidation loans, there is no credit requirement, and you have the right to consolidate only one time during the life of your loan.

Private loans can be consolidated, but will need to be consolidated like any other loans or debts -- applying for a loan with a private institution, obtaining credit, and doing everything else that’s required to obtain a loan from any bank. Unless the consolidation has a better interest rate or lower payments, there are no real benefits to obtaining a private consolidation loan.

Note that you cannot convert a private loan into a federal loan by consolidating. Nor can you consolidate the two together into a federal consolidation loan. This means that if you have a private loan, consolidating will not give you the benefit of federal repayment programs. And while it's possible to consolidate federal loans with a private loan, by doing so you will lose all the benefits of federal loan repayment programs, making it almost always a bad idea to consolidate federal loans into a private loan.

There are some very significant benefits to consolidating your federal student loans:

One of consolidation’s most powerful features is that it will immediately bring you current on your loan in the event you are in default. It will even stave off an administrative wage garnishment should you consolidate after notice of garnishment but before the garnishment is started.

In other words, your consolidation is a “get out of jail free” card that you can use once, and only once. It is usually best kept in your back pocket until absolutely needed. This is why it is not a good idea to just consolidate immediately after school, as you will lose the ability to do so later should you have a hardship.

Getting out of default is important for many reasons, a big one being that many of the federal income-based repayment plans (where you can reduce your student loan payment if you have a low income) require that you not be in default.

Qualifying for an Income Based Repayment Plan

Consolidation also can help you qualify for flexible federal student loan repayment plans such as the Income Based Repayment (IBR) and Income Contingent Repayment (ICR) programs. These programs allow you to make payments based upon your income, and forgive remaining principle after 20 or 25 years. (To learn more about these programs, see Federal Student Loan Repayment Plans.)

Here are some ways that consolidation can affect your ability to choose a repayment plan that’s best for you:

  • You can only obtain ICR with direct loans. If you have indirect loans, you can consolidate into a direct loan and then apply for ICR. (Learn the difference between direct and indirect loans in Nolo's article Federal Student Loan Repayment Plans.)
  • Perkins loans are eligible for ICR, but not IBR. Because IBR is a better (and newer) program, you can consolidate your Perkins loan, and then apply for ICR.
  • If you work in public service, and you have indirect loans, you will need to consolidate into a direct loan to take advantage of significant loan forgiveness programs for borrowers working for nonprofit or government organizations. (LINK)?
  • Never consolidate Parent Plus loans. Parent Plus loans disqualify you from IBR, and consolidating them into your other student loans taints the entire consolidation loan, meaning you will never be able to obtain IBR. If you have a Parent Plus Loan and must consolidate, do not consolidate the Plus Loan into your other loans. Instead, leave them out of the consolidation, and pay them separately, if you want IBR.

Making the Decision to Consolidate, or Not

Whether you can benefit from student loan consolidation largely depends on what repayment program you may qualify for, and what kinds of loans you have. Start by looking up your federal loans with the National Student Loan Data System, http://www.nslds.ed.gov/nslds_SA/. You can then determine whether your loans are eligible for the repayment plan you want to use. If not, you may have to consolidate to become eligible. If your current loans are eligible for the various repayment plans you are considering, then you might want to hold off on consolidating until absolutely needed.

Beware of Companies Charging for Loan Consolidation

If you do opt to consolidate, be wary of companies that want to charge you for assisting you in consolidating. Consolidation is done by completing a form which you can obtain from your servicer or lender, and you can consolidate as a matter of right. There is no need to pay a company hundreds of dollars to assist you in consolidating your loan.


Pros and Cons of Debt Consolidation Solutions

Student loan consolidation pros and cons

November 26th, 2013

Student loan consolidation pros and cons

After reviewing the terms of your accounts, and using a debt consolidation calculator, you’ve decided that debt consolidation is a good solution for you. Your next step, then, is to choose a method for consolidating and paying off your debts. The four most often-used strategies are balance transfers, personal loans, cash-out refinancing and home equity loans. Here’s a quick rundown of the pros and cons of each method.

Balance transfer cards are credit cards designed to replace one or more accounts with a lower-interest loan. The come with very low introductory fixed rates for a limited time. The idea is that you take advantage of this low-interest window to pay down your debts as quickly as possible. When you shop for a balance transfer card, you’ll be looking at the introductory rate, the introductory period, the annual fee and the balance transfer fee. Consider all of these costs when comparing cards.

  • The interest rate can be very low. Average introductory rate for balance transfer cards is about 2.5 percent. Average post-into rate is about 12.5 percent. Note: all average rates and fees quoted in this article are 2013 figures.
  • Exchanging multiple accounts for one account makes paying and budgeting easier.
  • Application and approval is quick and requires little effort.
  • Upfront fees are low.
  • You may not qualify for the advertised intro rate if your credit scores are not excellent.
  • There is typically a balance transfer fee. The average balance transfer fee is 2.88 percent of the amounts transferred.
  • The interest rate can spike if you’re 60 days late on your payment. That rate could be much higher than the rates of the accounts you paid off.
  • The introductory rate is good for a limited time, and then the rate increases. In 2013, the average introductory period is about 14 months.

Cash-out refinancing means replacing your current mortgage with a larger mortgage and taking the difference in cash. This can be used to consolidate debt or for almost any other purpose.

  • Because the loan is secured by your home, the interest rate is much lower than that of debt like credit card balances. Average cash-out refinance rates in late 2013 are about five percent.
  • The interest may be tax deductible (check with a tax pro).
  • You can lower your monthly payment significantly, because home mortgages can have much longer terms. Stretching out your credit card debt with a ten- to thirty-year loan really lowers drops your payment.
  • You can a better rate than that of your old mortgage.
  • The loan is secured by your home, so if you can’t make the payment, you could end up in foreclosure.
  • Credit card debt can be discharged in a bankruptcy because it’s unsecured. Once that debt is secured by a home, you can’t discharge it with a Chapter 7 filing.
  • Cash-out refinances take time. There’s an application, an appraisal, a title search, etc.
  • Cash-out refinancing has higher upfront costs than any other strategy. It’s a good solution only if the new loan has better terms than the mortgage it replaces.
  • Stretching out your repayment can increase your total interest expense, even if the interest rate is lower. This can be prevented by making extra principal payments to lower your balance.

Home equity loans and home equity lines of credit (HELOCs) are also called second mortgages. Like cash-out refinancing, they let you trade home equity for cash, which can be used to consolidate your debts. Home equity loans can carry fixed or variable rates. Fixed rates, however, make budgeting easier. Home equity terms range between five and 25 years, with the average being 15 years.

  • Because the loan is secured by your property, the interest rate is lower. Average home equity loan rates in late 2013 were about seven percent.
  • The interest is likely to be tax deductible. Check with a financial advisor.
  • Replacing multiple accounts with variable rates, like credit cards, with a single fixed rate loan makes managing debt much easier.
  • Home equity loans have much lower costs than cash-out refinances and can be processed much more quickly.
  • Stretching out your debt repayment over more years can substantially lower your payment.
  • Like cash-out refinancing, a home equity loan increases the amount of debt secured by your home. Should you find yourself unable to make the payment, you could end up in foreclosure.
  • Debt moved from unsecured accounts to a mortgage (which is what home equity debt is) can no longer be discharged in bankruptcy. If your finances are shaky, a mortgage is probably not your safest choice.
  • Stretching out your debt over a longer timeframe may increase the total interest cost, even if the interest rate is lower. This can be avoided by accelerating your repayment with extra principal payments.

Also called signature loans or unsecured loans, personal loans have no collateral — the lender’s only security is your character and your ability to repay the debt. The rate you pay and the amount of credit you’re offered depend on your credit rating — most lenders assign their applicants a grade between A and F. If you see a “personal loan” advertised with “no credit check” or “bad credit okay,” it’s not a personal loan. It’s a title loan or paycheck advance, and it’s very expensive. Rates for real personal loans generally range between six and 36 percent in 2013.

  • Personal loans almost always have fixed interest rates, making budgeting easier.
  • Application and processing are very fast. You can often get a personal loan in one day.
  • Personal loan fees are much lower than those of home equity loans or cash-out refinances.
  • Terms range from one to five years, so you become debt-free faster.
  • Personal loans can be discharged in a bankruptcy.
  • Personal loans are unsecured, so their interest rates are higher than those of home equity loans or cash-out refinances.
  • Because terms are shorter, payments are higher.
  • If your credit isn’t very good, you may not be able to get a lower rate than you’re currently paying on your credit cards.

The goal of debt consolidation should be to get debt-free more quickly and / or at a lower cost. And so the one big con of all methods is that people without the discipline to stick to their debt repayment program may run their cards back up. Then they have their debt consolidation loan plus all their credit card balances. Experts estimate that this happens to between 50 and 85 percent of people who try debt consolidation. Make sure you aren’t in that camp before trying any of these methods.


Debt Consolidation Loans: Pros and Cons

There are times in most people’s lives when they become burdened with too much debt. They may have a mortgage, car loan, student loans, and credit cards… All of these have monthly payments that eat into the paycheck leaving little left over for all the other bills – groceries, insurance, electricity, living…

And then another catastrophe happens, the car breaks down resulting in a massive repair bill. It appears nothing short of winning the lotto will dig them out of this pit of debt now.

While explaining the situation to their banker, he comes up with what seems to be the answer: a debt consolidation loan (which has its pros and cons). He suggests you take a new loan to pay off the car, the student loan, the credit cards and the car repair bill. You will have just one monthly payment that is significantly less than what you were paying previously.

This sounds too good to be true, and it just might be if they are not careful.

Types of Debt Consolidation Loans

There are four ways in which debt is usually consolidated. These are personal loans, personal lines of credit (LOC), home equity lines of credit (HELOC), and mortgage refinancing.

Loans are given to people all the time. They can be used for personal items such as a car, a vacation, or to pay for medical bills. The repayment terms are negotiable so that the time to pay off the loan and the monthly payment amount can be tailored to meet the borrowers’ needs and ability to pay. Another feature of personal loans is that lump sums, including the full amount, can applied at any time without penalty

The personal line of credit is an open loan to certain credit limit. The borrower is able to take money from the LOC for any purpose up to a certain limit, e.g. $50,000. The monthly minimum payments will fluctuate depending on the outstanding balance. Like a personal loan, the outstanding balance can be paid out any time.

Home Equity Line Of Credit

The HELOC operates the same as a personal LOC. The difference is that the bank secures the loan with the borrower’s home. This also results in lower interest rates because of the security.

If the borrower’s home has enough equity, the banker may suggest refinancing the property to use some of the home’s equity to pay off the debts that have accumulated. The advantage to mortgage refinancing is the lower interest rates on mortgages compared to other loans.

Debt consolidation usually reduces the interest being charged and lowers the monthly payment. But it usually extends the payment period out over a longer time frame. This extension of payments means that a person could ultimately pay more for those items.

The mortgage refinance can be the worst. Consider a car loan for $25,000. Based on 8% interest on a five year loan, the monthly payment will be $506. If no lump sum payments are involved, the car will cost $30,400 of which $5,400 will be interest. Compare that to a mortgage refinancing, the terms are 5% over twenty-five years. The final cost of the $25,000 car will be $43,800 of which $18,800 is interest! Will the car even last that long?

The second pitfall has to do with personal attitudes and emotions. It happens far too often that the borrowers do not change their lifestyles. Once the debt has been consolidated into a single and affordable payment, they become complacent about their spending. Sometime in the future, they find themselves in the same situation where credit cards are at their limits, and a new car has been purchased. Equity in the home is used like a personal ATM cash machine. They once again refinance the home to pay off these new debts while the old debts are still not paid off. Now how much is the first car going to cost? Refinancing charges have not been mentioned but they will be applied to further compound the payments.

Debt is a normal part of most young adults’ lives. And there are times when debt consolidation makes sense. It makes sense to replace high interest debt (credit cards) with lower interest debt, and to reduce monthly payments without extending the term to pay back. The goal is to repay the debt as quickly as possible.

The best way to consolidate debt is the HELOC because of the lower interest rates charged and the pre-payment options. A personal LOC or personal loan is preferred over the mortgage refinance.

Once the method of consolidation is chosen, a plan is needed. The plan is to pay more than the monthly minimums and to add lump sum payments to accelerate the pay down of the loan and to reduce interest costs. The second part of the plan is about the borrowers, their attitudes and emotions; the commitment and the discipline to follow the debt repayment plan is needed. And more importantly, they need the commitment and the discipline to live within their means.