The Pros and Cons of Consolidating Student Loans
The current economic climate has caused a large number of people unemployed and employed, to return to school. The goal is to improve your marketability and hopefully land a better paying job or just a job. Most adult learners (name given to those returning to school after age 22) will spend 2 to 5 years in some form of higher education and on average accrue $20,000 – $50,000 worth of debt. After graduating, the educational debt may be higher than the annual income of their new career with a monthly loan payment of about $250.00. The student must consider the best option for paying off multiple loans acquired in school. Most students have to decide if consolidating student loans is a wise decision? The pros and cons of consolidation explained below will hopefully provide insight into the best option for you.
First, you should know the differences between federally funded and private loans. Most students take out federally funded loans for tuition, books, technology fees and other educational necessities. While, private loans cover what federal loans will not such as, living expenses if they are going full-time. Federally funded loans have a fixed interest rate, which into effect in 2006. This means wherever the interest rate is in the market when you took out the loan, is where it will stay for the entire life of the loan. Prior to this change, students had variable rate loans and could lock into a lower interest rate. On the other hand, private loans can either be fixed or adjusted. This is important to note because you cannot consolidate these two types of loans together.
Second, there is no real financial benefit to consolidating your federal loans. Most people believe they will save money or the idea of having one payment as opposed to 2 or 3 is very appealing. In actuality it is not true. If you can pay off your loans independently of each other you should. But, if you are having difficulty making payments or foresee a problem and need smaller monthly payments, then consolidation may be right for you. There are many repayment options available, but just note that consolidating your loans will extend out the life of your repayment. So you could go from paying $365.00 a month on a $20,000 loan for 5 years to $185.00 a month for 10 to 15 years. Also, the interest will continue to accrue which will make your $20,000 initial loan end up costing close to $40,000.
Third, there may be real financial benefit to consolidating your private loans. For instance, if you have an adjustable interest rate on the private loan, you can get a reduce interest rate, particularly if you have a great credit score or impressive employment history. Also, consolidating private loans can get your co-signer removed off your loan and reduce their financial burden.
Forth, you can consider another option called the income-based repayment plan. This became available in 2009 and is a great alternative for graduates entering into fields with low salaries. The payment plan is based on the range between a person’s annual adjusted gross income and 150% of the federal poverty line. The payment is capped at that amount unless the person’s income increases and then the monthly payment increases. A bonus benefit of this plan is if you do not have your federal loan paid off within 25 years, the remaining debt is forgiven.
Fifth and last point, make sure you understand and read the loan information carefully before signing. Ask about penalties on the loan, prepayment fees (which should be avoided if possible), how long it will take to pay off the debt and the maximum interest rate on the loan. Also, ask someone close to you or your co-signer to read and ask questions as well.
Although student loans are a part of almost every student’s educational career they can be managed and paid effectively and quickly so you can enjoy financial freedom from this debt.