Most students today are coming out of advanced schooling with a degree and a load of student loan debt. Those payments can really add up as well. It isn’t uncommon for payments to be as high as $400+ per month. Even with income-based repayment schedules, it can be nearly impossible to afford every monthly payment from every student loan that exists.
That’s why evaluating the pros and cons of consolidating student loans becomes a high priority for recent graduates. These key points show the advantages and disadvantages that come from deciding to make one payment instead of multiple payments every month.
What Are the Pros of Consolidating Student Loans?
1. It improves personal finances almost immediately.
Most student loans that are approved are often treated as individual loans. Since loans may cover just a semester and a student may receive two loans to cover costs, there may be 15+ loans that require payment upon graduation. Consolidating them into one payment can lower monthly payment requirements by 67% or more.
2. It locks in a guaranteed interest rate.
The interest rates on student loans aren’t governed by the free market economy. They’re governed by the government. Congress in the US has the authority to raise student loan interest rates whenever they want to do so. Unless consolidation happens, there is no way to lock in the interest rate, which means there is no actually guarantee on the amount that needs to be repaid over time.
3. Sometimes interest rate discounts are allowed.
Although not all consolidation loans allow it, there are incentives in place for students to receive interest rate discounts. Automatic payments, a certain amount of on-time payments, and other actions can often reduce the interest rate on a loan by as much as 2%.
4. It allows you to pay extra on your student loans each month.
Because there are lower minimums with a consolidated student loan, it becomes possible to pay them off much more quickly by paying down the principal amount when there is extra money floating around. This can shorten a 25 year obligation to 10 years with only a few extra dollars every month.
5. It provides the chance for better returns.
If you can lock in an interest rate of 3% on your student loans, but receive a 10% return on the investments you’re making, then what you have is called a “good debt.” It means your returns outpace the debt interest that you must pay to stay current. In these circumstances, carrying the debt can actually be better than trying to pay it off early.
What Are the Cons of Consolidating Student Loans?
1. The repayment terms are extended.
Because all of your student loans are being combined into one payment that is lower, the length of the loan is extended. A 5 year loan, for example, could become a 15 year loan. That means you’ll be paying lower amounts, but you’ll be paying on that loan over a longer period of time and that ultimately means more interest could be paid long-term.
2. It limits the amount of a student interest tax deduction.
Student loan interest is often a tax deductible item. Paying multiple loans at once creates a higher deductible amount every year. Only having one loan limits the amount of interest that gets paid and that means there could be a greater tax liability every year because of the student loan.
3. It creates a brand new loan.
Once you consolidate all of your student loans into one financial product, your other student loans are marked as being “closed” on your credit report. A number of closed accounts can actually have a negative effect on your credit score, even though you’re improving your overall finances. This can then limit your purchasing power for other items when needed, such as a vehicle or a home, because of the perceived negative marks that are seen.
4. You lose control over debt management.
It isn’t uncommon for financial institutions to sell their obligations of a student loan to others. With just one consolidated loan, you lose a lot of control over who and where your loans are being managed. You might sign up for friendly terms, but once that loan gets sold, those terms might get changed with proper notice.
Consolidating student loans pros and cons focus on cash flow. If you can improve the amount of liquid cash that is available to you through a loan consolidation, then this may make sense to do. If it creates additional financial management issues or tax liabilities, however, then the disadvantages may be greater than any benefit received.