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Consolidating student loans

A good way to help ease the burden of student loans is to consolidate them into a single loan. Find out how it works, and if it's a good choice for you.

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Let’s take a look at a few of the pros and cons of consolidating your student loans.

If you have multiple student loans, consolidation can offer some simplicity to your repayment. Essentially what happens when you consolidate is that all of your original loans are paid off by your lender and replaced with a single new loan with new terms. And you can often get a lower monthly payment because you will have a longer repayment period – so there are some trade-offs to keep in mind.

Let’s look at an example of getting a federal consolidation loan—you can also get a private consolidation loan if you have private loans, but we’ll get to that in a minute.

Let’s say you have $50,000 in federal loans. Fifteen thousand dollars in subsidized loans with a 3.5% interest rate, and then two different unsubsidized loans: a loan of $20,000 with a 4% interest rate, and a loan of $15,000 with a five percent interest rate.

[Show example, with interest rates.]

If you’re not sure about the differences between unsubsidized and subsidized loans, we cover this in another video.

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Now as you can see, keeping track of these loans might get complicated—especially if you’re making payments to different loan servicers.

Entering these numbers into the loan calculator at studentaid.ed.gov—on a standard 10-year repayment plan, you’re going to be paying a little over $500 a month. Over 10 years, you’ll pay about $11,000 in interest on your original principal of $50,000.

Now let’s say you want to consolidate these loans. Under your new loan terms, your loans will be consolidated into one $50,000 loan—and you’ll have one new fixed interest rate, which is determined by taking the weighted average of the interest rates on your previous loans, and rounding up to the nearest one-eighth of one percent. In this case, that’s 4.25%.

Now, entering your loan information into a loan consolidation calculator, you’ll find that consolidating your loans gives you a new repayment period, which is figured based on the amount you owe – the more you owe, the longer this repayment period will be.  It can vary from 10 to 30 years, but in this case it’s going to be 25 years.

And your new monthly payment will be about $270. That’s a lot less than the $500 a month you would have spent on a standard 10-year repayment plan. But, paying $270 per month for 25 years means you’ll be paying a total of about $81,250 over the life of your loan.

Subtract your original $50,000, and you’ll see you’re paying over $31,000 in interest, compared to the $11,000 you’d pay on the standard 10-year plan.

So while simpler and lower monthly payments might give you some relief in the present, the trade-off is that it can cost you a lot more over time.

You will also have new loan terms. This means that you may miss out on some of the repayment benefits you might have been eligible for on your previous loans, like interest free deferment on subsidized loans or loan cancellation for special circumstances. But if you do decide to consolidate your loans, it's good to keep in mind that you always have the option of paying more than your monthly payment, which can save you money over time, while still having the flexibility of not having to make the higher monthly payments that you would have on a standard 10-year plan.

But everyone's situation is different. If you're struggling to make payments on your original loans, you might consider repayment options other than loan consolidation, like an income-based repayment plan. Or if you run into a financial hardship and need short-term relief, you might consider deferment or forbearance. These options are covered in detail in other videos.

Now, if you have private student loans, you also have private loan-consolidation options. They work much like a federal consolidation loan, except they also take into account your credit score when determining your interest rate. So if you have a lower credit score, you might be looking at a higher interest rate. If you’ve just left school, you probably haven’t had the chance to build up a good credit history yet, so with private consolidation you might get a simpler, lower monthly payment, but you could end up paying more in combined interest.

But if you happen to have a steady job and have built up a good credit score, you might be able to get a lower interest rate from another lender than your current private loans, so it might be worth looking into.

So while loan consolidation can make your monthly payments simpler if you have multiple loans with different interest rates, you could end up paying a lot more if you extend your repayment period. But by comparing the pros and cons of each repayment plan available, you’ll be able to find out which option is right for you.

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