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Risks and Costs of Student Loan Consolidation

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With more and more students starting and finishing up school every year, dealing with student loans has risen as well.

In 2014, 70% of all graduating seniors came away from school with some form of student debt.

The average debt carried by these students was just under $29,000. Add to that the fact that student debt has risen at twice the pace of inflation.

You now have a situation where students are between a rock and a hard place once their loan deferment expires, making the monthly payments turns into a big stress.

Enter the Federal Direct Loan Consolidation program.

This program allows students to lump together all of their student loans into a single loan, allowing the qualifying student to reduce his or her payments to a single one, instead of five to ten payments.

The government even decided to eliminate any kind of up front application fee to potential borrowers to make it easier for everyone to apply.

What Loans can You Consolidate?

Any federal student loan, with the exception of the Federal PLUS Loan made to the parent of a dependent student, can be consolidated by the student.

All the other loans, like Direct Loans, Stafford Loans, and Perkins Loans, qualify.

The application has an exhaustive list of all the loans that can be consolidated.

However, if you are in default on your loan, you can also find yourself on the outside, looking in.

Chances are, you won’t qualify unless you are able to work out a rehabilitation agreement with your student loan provider. Then, once the loan has been rehabilitated, you can begin the consolidation application process.

Private student loan consolidation is an option for borrowers who are looking to consolidate both federal and private loans.

The largest student loan consolidation company, SoFi, saves borrowers over $14,000 on average.

Today, there are over 10 different private student loan refinancing and consolidation companies.

Be aware, none of these companies are working with the Department of Education. And, some of these lenders do not approve everyone for refinancing.

What are the Costs?

When you consolidate your loans, you will pay a slightly higher interest rate than before.

The interest rate takes the weighted average of your loans and rounds up to the nearest 1/8th of a percent. So, if your weighted interest rate is 7.1%, then your consolidated interest rate will be 7.15%.

It’s not a huge increase, but, if you are paying the loan over 30 years instead of the initial 10, you will be paying $21,472.88 in interest, instead of $5,992.24, an increase of $15,480.64.

So, while you might be paying $70.00 less per month, in the long run, your interest is nearly tripled.

Additionally, while you won’t be paying any fees up front to apply for the loan, you are still going to have to pay a loan fee at the end of the transaction.

If you have an undergraduate loan the fee will be a little over 1% of the loan amount, while graduate school loans will include a 4.3% fee.2

That means if you consolidate $15,000.00 in undergraduate loans, you will have an additional $259.00 tacked onto your loan. If you have $15,000 in grad school loans, the fee will look more like $644.00.

Is Consolidation the Right Choice for You?

Every situation is going to be different when it comes to consolidating your loans.

If you are strapped for money, you can increase your cash flow significantly by extending your payments over a longer period of time.

You could be looking at reducing your payments from $600.00 per month to $300.00 per month.
However, if you only have a couple of years left, or even just a couple thousand dollars remaining on the loan balance, consolidation won’t be worth it.

On top of that, if you are consolidating just to decrease your monthly payment by extending your loan term, you really need to think twice.

Like I mentioned above, you will end up paying triple the interest at the end of the day, when you might be able to afford your regular payments now.

Finally, you could run into trouble when you try and purchase a home.

With new regulations governing Fannie Mae, Freddie Mac, the FHA, VA, and even the USDA, even if your student loans are on an income based repayment plan, or are in deferment, regardless of the payment amount, those organizations will count one or two percent of your total loan amount against your debt to income ratio.

You will find that the total amount of home you can afford will decrease drastically, and could disqualify you all together.

So, before you make the decision to consolidate your student loans, be sure to look at the numbers, what you can afford, and seriously think about whether you want to trade convenience for a whole lot of interest.

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