Although student loan consolidation options may seem the same, at a glance, they are, in fact, quite different. Variables in interest rates, benefits, and payment options are just a few of the difference that you will notice after carefully investigating your loan consolidation options. The purpose of this guide is to help you to better understand the process as well as some of your options.
What exactly is student loan consolidation?
The term, consolidation, means “to combine”. From an outsider’s point of view, this is what loan consolidation looks like. However, a closer look indicates that the term is a bit deceptive.
Upon the completion of a successful loan contract, your new lender purchases all of your student loans. Generally, they go to each individual lender and discuss terms for repayment, purchasing the loans for the principal amount and any interest that has accrued thus far. This amount is less than the amount you would have paid over the life of the loan. This is how your new lender makes money.
They have now acquired your loan for a lesser amount. The new lender now offers you a new loan on the amount that it cost them to purchase your loans. This loan has a new interest rate. You now have a new lender, a new loan, and a new interest rate.
How is interest determined
Interest rate is determined by what is called the “weighted average” of your current interest rates on the day that you applied for the loan. To calculate the weighted average of your current interest rate, the amount of each loan is multiplied by the interest rate. These numbers are your “weight factors”. The weight factors are now added together. The amounts of your loans are added together. The weight factor total is divided by the loan amount total and multiplied by 100. This is your weighted average interest rate.
Government consolidation loans are capped at 8.25%. This means that the interest rate of your loan cannot exceed this amount. This regulation does not govern private lenders. This is something that you should be aware of when researching different types of lenders.
Many loan options, two basic categories
As mentioned above, there are two basic categories for student loan consolidation; government and private lenders. Under each category of lenders, there are many subcategories. Each subcategory has its own benefits and disadvantages.
If all of your student loans are government loans, your best option is to search for government loan consolidation. This is because interest rates are not variable. They are fixed rates. Government consolidation loans also do not base their rates on credit. Instead, repayment options, interest rate, and length of the loan are determined by the government. This provides you with two notable benefits.
The first benefit is that, since government consolidation loans do not vary in rates and terms, they must offer benefits in order to compete. These benefits are their way of gaining your student loans. Secondly, government loans offer you more flexible options in respect to repayment plans. Options like income sensitive repayment, loan deferment, and graduated repayment are offered through government loans. These options are not available through private lenders. Unfortunately, you cannot combine private and government loans with government lenders.
Private lenders do allow you to combine government and private loans into one consolidation plan. Although interest rates are not capped, many private lenders offer incentives and lower interest rates for timely payments and automatic withdrawal from your account. Private lenders usually require a credit check, unlike government lenders. Interest rates are based on the results of your credit check. If you have bad credit, you may have a difficult time finding a private lender or experience high interest rates.
Not without problems
Although student loan consolidation can offer a number of benefits to borrowers, it is not without problems. Many borrowers end up repaying thousands of dollars because of extended payment plans and interest rate fluctuations. Others lose valuable benefits because they were not aware of the benefits that their original loan had to offer. This is most common for students and graduates that consolidated their Perkins loan. Perkins loans come with a large number of benefits, including debt cancellation if you meet certain criteria.
There are other options
Consolidation is not right for everyone. In fact, many students and graduates find it to be an ineffective means of managing their educational debt. There are other options like debt forgiveness and volunteer work that can assist you in managing your student loans. Consolidation is not your only option.
Carefully researching different lenders, understanding your current loans, and comparing the results can help you to make the best financial decision for your situation. Never settle on the first lender that you speak to. If in doubt about a lending institution, seek the aid of the Department of Education.