Student Loan Consolidation 101

If you have more than one student loan after college, chances are you’ve been approached by more than one group seeking to consolidate your student loans (if you haven’t graduated yet and have multiple loans… just wait). These groups promise all sorts of things, from a percent reduction in your balance to a low interest rate, to get you to consolidate your loans through them. When I first started receiving these calls, I was completely lost, but after doing some research, asking a lot of questions, and finally going through with it, I discovered several key facts about loan consolidations that are well worth sharing.

If you’re unsure about what a student loan consolidation even is, it is essentially a loan swap in which you get a brand new student loan that equals the combined balance of all of your other loans. A consolidated loan often has a somewhat lower interest rate than the other loans, but this lower rate is balanced out by the fact that the term of your consolidated loan is effectively reset, meaning that a consolidated loan repayment ends at a later date than the original loans – you’ll be paying less interest per year, but you’ll be paying it for more years.

First of all, never, ever give any personal information to anyone who calls you wanting you to apply for a student loan. You have no idea who is on the other end of that line and giving your personal information to them is a sure way to get yourself locked in – to identity theft. This isn’t a suggestion, it’s a rule – never, ever give any of your personal information to anyone who calls you in an unsolicited fashion.

Now, about the things they’ll tell you if you’re thinking about consolidating: in truth, there are really only two benefits to consolidation: it can lower your monthly payments (as well as potentially lower the overall amount you’ll have to pay if you’ve just started repayment) and it also means that you’ll only have to deal with one loan company for all of your student loans – no more multiple payments. However, there is a chance that it may actually increase the total interest you might pay over the life of your loans if you’re not careful. Some lenders will make other claims, such as stating that it will help your credit report out, but that’s largely false – the formula that generates your credit score accounts for multiple student loans without breaking a sweat. Let me repeat: consolidation of student loans will not affect your credit history.

How will you know if a student loan consolidation will save you money? There’s really no way of knowing without running all the numbers yourself, and that can be fairly complicated. However, if you’re very early in the life of your loan, you can get a pretty accurate number to work with by multiplying each of your loans by its respective interest rate and adding them together, then dividing that number by the total of all of your loans. For example, let’s say you had two loans for $20,000 each at 7.5% interest, and one loan for $15,000 at 8.5% interest. Take $20,000 and multiply it by 7.5%, which gives you $1,500 (and you have two of those, so it’s $3,000 total), plus $15,000 times 8.5%, which is $1,275, giving you a total annual interest of $4,275. All of the loans added together are $55,000, so divide $4,275 by $55,000 to get 7.77%. If your consolidated loan doesn’t beat that by at least a little, it’s not worth consolidating, and the older your loans are, the greater the difference needs to be to consolidate. If you’re past the five year mark or so, it’s almost never worth consolidating because the interest rate benefit will be eaten up by the longer term.

Also, some offers will include a small percentage reduction in your balance. Basically, a balance reduction is worthless if it doesn’t come packaged with a very competitive interest rate because even a 0.5% higher interest rate will undo the benefit of a 3% balance reduction over the lifetime of the loan.

Note that consolidation will not remove a defaulted loan from your credit history. A defaulted loan is serious bad news for your credit report, and it’s even worse if you consolidate before dealing with that loan. Why? Even though it’s now marked “paid in full,” it’s also still marked as being in default and that mark will stay on your credit history for seven years. Rather than consolidating, do whatever you have to do to get that loan rehabilitated before you consolidate.

In other words, you should really only consider consolidation if you are current on all of your loans, you haven’t been paying on them for too long, and you can get a distinctly lower interest rate. If you answer “no” to any of these, a student loan consolidation is probably not for you.

Trent Hamm
Trent Hamm
Founder of The Simple Dollar

Trent Hamm founded The Simple Dollar in 2006 after developing innovative financial strategies to get out of debt. Since then, he’s written three books (published by Simon & Schuster and Financial Times Press), contributed to Business Insider, US News & World Report, Yahoo Finance, and Lifehacker, and been featured in The New York Times, TIME, Forbes, The Guardian, and elsewhere.

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