Student Loan Consolidation: Solutions For Repayment Nightmares

Last updated on November 15, 2017

Student loans are a hot topic over the past years as many college graduates are having difficulty finding jobs in a tough economy. Many graduates are facing tough choices like taking low paying jobs, working more than one job, furthering their education with graduate classes and even moving in with their parents.

Related to the topic of student loans is student loan debt consolidation.

Consolidating your student loans can be one option that can help you lower your payments, stay on top of your finances and manage only one loan instead of juggling multiple loans with multiple interest rates. However there are also many disadvantages to loan consolidation, including longer repayment periods, additional accrued loan interest and the loss of any grace period from your current non-consolidated loans.

The question of loan consolidation remains up to the individual student. However, since hundreds to thousands of dollars in potential savings are at stake, it should be a matter of importance to find out the best option for you.

Is Consolidation Right For You And What Loans Can You Consolidate?

There are many advantages and some disadvantages to consolidating your student loans. There is also misinformation regarding the loan consolidation process and the perception that consolidating student loans will cause a complete loss of all benefits. Listed below are just a few of the well-known advantages and disadvantages to consolidating student loans.

Advantages:

  • Making one monthly payment to one lender.
  • Lower monthly payments.
  • Extended time to pay off your loans.
  • Lower interest rates.
  • Repayment options are still available on most loans

Disadvantages:

  • Paying more interest over the entire life of the loan.
  • Longer repayment periods.
  • Some loss of benefits, such as grace periods
  • The inability to consolidate private student loans.
  • No consolidation for loans while the student is still in school.

Just about any kind of federal student loan can be consolidated into a Direct Consolidation Loan. Here is just a list of the most common student loans that are taken out that can be consolidated into a Direct Consolidation Loan.

  • Federal Subsidized and Unsubsidized Stafford Loans
  • Federal Subsidized and Unsubsidized Direct Loans
  • Perkins Loans
  • Subsidized and Unsubsidized Federal Consolidation Loans
  • Guaranteed Student Loans
  • Federal Plus Loans (parents, graduate students or professional students)
  • Direct Plus Loans (parents, graduate students or professional students)
  • Direct Plus Consolidation Loans
  • Parent PLUS Loans
  • Health Professional and Health Education Loans

Private Student Loans

Only federal student loans, like the ones mentioned in this article, are eligible for a Direct Consolidation Loan. Private student loans aren’t eligible for federal debt consolidation because private loans don’t follow the same rules that federal student loans follow. Those students that wish to consolidate their private student loan debt will have to use traditional debt consolidation methods as one would with credit card debt. There are companies that specialize in the consolidation of private student loans, and they can offer competitive interest rates too. Students also cannot consolidate private student loan debt with federal student loan debt.

Understand The Need For Student Loan Consolidation

Doesn’t everyone have one type of loan with one lender?

Many people will wonder why student loan consolidation is used at all when the typical college graduate will only have one type of student loan through one lender. After all, federal student loans for both subsidized and unsubsidized loans have the same interest rates for each student with any lender. The difference lies with how your college education is funded.

Undergraduates – Undergraduates will typically take out the Stafford loan, and the loan is either subsidized, unsubsidized or a combination of both. These interest rates are fixed (currently 6.8% for unsubsidized and 3.4% for subsidized), and students will usually stick with the same lender. However, it’s possible that for one or more years the student showed a great financial need, and they were eligible to take out a Perkins loan at a 5% interest rate with a different lender. The undergraduate student will find themselves with multiple lenders and multiple interest rates.

Graduates – Graduate students could be eligible for Stafford loans, but could also take out PLUS loans (currently 7.9%). Some graduate students have come back to school after many years, and their interest rates and lenders will be different.

As you can see, it’s possible for undergraduate and graduate students to have multiple loans with multiple interest rates held by multiple lenders. Consolidating your student loans will help better organize your finances by making one payment to one lender with one fixed interest rate.

What Are The Interest Rates On Direct Consolidation Loans?

Direct Consolidation Loans use a weighted average to calculate the interest rates of your individual loans to come up with a fixed rate on your consolidated loan. Calculating the weighted average is easy. First, let’s come up with a hypothetical scenario where a student recently graduates from college with an undergraduate and graduate degree and has three different loans with different interest rates.

Loan #1          $25,000 @ 4.5%

Loan #2          $15,000 @ 6.8%

Loan #3          $7,500   @ 6.8%

The calculation for weighted average is as follows:

Step 1- Multiply each loan amount by its interest rate.

Our example:  25,000 * 4.5 = 112,500    15,000 * 6.8 = 102,000    7,500 * 6.8 = 51,000

Step 2- Add your totals.

Our example:  112,500 + 102,000 + 51,000 = 265,500

Step 3- Divide total amount by total student loan amount. This will be your weighted average interest rate.

Our example:  265,500 / $47,500 = 5.58% 

Does Weighted Average Mean Anything?

The answer is yes and no. If you don’t consolidate your student loans, and your interest rates are fixed, then consolidating your loans and using the weighted average will not make a difference in your monthly payment. However, not all interest rates are fixed. Variable interest rates can go up and down over the life of the loan. Consolidating your loans that have low variable interest rates into one fixed rate through loan consolidation is a smart decision. You can potentially save thousands of dollars in interest should your variable rates increase substantially.

Advantages

One Payment, One Lender

The biggest advantage to having a consolidated loan is one monthly payment paid to one lender. This helps borrowers make payments more efficiently, on time and avoid late fees and other penalties.

Loan Size Matters

The size of your loans does make a difference. The more money owe the longer your repayment period will be. This is important if you are looking to keep your monthly payments low while you get financially established as you start out with your life after graduation. You know by now that the Standard Repayment Plan most graduates typically have include a repayment period of 10 years, or 120 months. However, the following table illustrates a revised repayment period you are allowed to use for the Standard Repayment or Graduated Repayment Plans.

Figure 1

Repayment Period for the Standard and Graduated Repayment Plans
Loan Amount Repayment Period
< $7,500 10 years
$7,500 – $9,999 12 years
$10,000 – $19,999 15 years
$20,000 – $39,999 20 years
$40,000 – $59,999 25 years
More than $60,000 30 years

Consolidating your student loans creates a single loan balance much larger than your individual loan balances. Therefore, you can take advantage of consolidating your loans to get a longer repayment term and lower your monthly payment.

Lower Monthly Payments

As previously mentioned, a larger student loan balance means you can get a lower monthly payment. Consider the scenario using the three typical loan amounts and their combined monthly payments, and compare it to a monthly payment using a consolidated loan.

Figure 2

Loan #1 Loan #2 Loan #3 Consolidated Loan
Loan Amount $25,000 $15,000 $7,500 $47,500
Repayment Period and Interest Rate 20 years 4.5% 15 years 6.8% 12 years 6.8% 25 years 5.58%
Monthly Payment $158 $133 $76 $294
Combined Monthly Payment = $367 Monthly Savings = $73

Remember that the individual interest rates are collectively the same as the consolidated interest rate. However, consolidating your loan will initially save you $73 per month for the first 12 years of the loan repayment period. Again, this could be an amount of money that can really help out graduates who are just starting out with new jobs and other bills to pay.

Many Payment Plans Still Accepted

You can still take advantage of many payment plans under a Direct Consolidation Loan as you would if you had not consolidated your loans. Payment plans under Direct Consolidation include the following:

1. Standard Repayment Plan

You can pay your Direct Consolidated Loan using the Standard Repayment Plan for up to 10 to 30 years as indicated in Figure 1. Making loan payments under the Standard Repayment Plan pays off your loans in the shortest amount of time with the least amount of interest.

2. Graduated Repayment Plan

The Graduated Repayment Plan allows you to make lower monthly payments at the beginning of your repayment period and larger monthly payments towards the end. Your monthly payments will increase every two years for up to 10 to 30 years depending on the size of your loan. The minimum payment you make must be equal to the accrued monthly interest.

3. Extended Repayment Plan

The Extended Repayment Plan allows you to choose from a fixed repayment option or a graduated repayment option for a repayment period of up to 25 years. Your total loan debt must exceed $30,000 to be eligible for the Extended Repayment Plan. This makes loan consolidation important if you have several loans with smaller amounts that add up to exceed $30,000.

4. Income Contingent Repayment Plan (ICR)

The Income Contingent Repayment Plan uses your annual income, your loan balance, your family size and a 25-year repayment period to determine your monthly student loan payment. Any remaining loan balance after the 25-year repayment period will be forgiven.

5. Income Based Repayment Plan (IBR)

You can consolidate your student loans with a Direct Consolidation Loan and still take advantage of the Income Based Repayment Plan. Under this plan you will pay only 15% of your adjusted gross income (AGI) that is above 150% of the poverty rate for your given family size. Unlike the Income Contingent Repayment Plan, which uses your loan balance to factor in your monthly payment, the size of your consolidated student loan doesn’t matter. If the balance on your loan is not paid off by the end of the 25-year repayment period then your remaining balance is forgiven.

You must experience financial hardship to be eligible for the Income Based Repayment Plan, and you cannot change to another plan except the Standard Repayment Plan should you choose the IBR.

Disadvantages

Although a Direct Consolidation Loan does have many benefits, such as lower monthly payments to a single lender, there are also some disadvantages to getting a Direct Consolidation Loan too.

Longer Repayment Periods

If you choose to take advantage of the longer repayment period, then you will need to keep in mind that you will remain in debt for a longer period of time. Getting out of student loan debt as soon as possible allows you greater flexibility with other financial decisions. For example, if you are purchasing a home, then your debt to income ratio will be higher if you still have student loan payments. This could be the difference between qualifying for a home that you really want and settling for a less expensive home that better fits your budget.

More Interest Paid Over Time

Interest will continue to accrue the longer you hold onto your student loan debt. Low payments are great, but it does come at a cost. Consider the following example of using a total student loan debt of $30,000 using a standard repayment of 10 years versus using the Extended Repayment Plan that allows you 25 years to pay your debt.

Total Accrued Interest Standard Repayment Vs.Extended Repayment Plan
Loan Amount Repayment Term and Interest Rate Monthly Payment Total Payments Accrued Interest
$30,000 120 months @ 5% interest $318.20 $38,184 $8,184
$30,000 300 months @5% interest $175.38 $52,614 $22,614

As this table illustrates, there is a substantially greater amount of interest paid over 25 years compared to paying your loan over 10 years. The difference is $14,430 in additional accrued interest. The lower monthly payment of $175 looks attractive to graduates just starting out, but if one can afford the $318 monthly payment then they will save money in interest and enjoy more disposable income after 10 years.

Losing Your Grace Period

You will lose any grace period that you have on your federal student loans under a Direct Consolidation Loan. The Stafford loan grace period is six months after graduation, and the Perkins loan grace period is nine moths after graduation. Should you choose to consolidate these loans you will lose any eligible grace period and your payments will begin within 60 days of your loan consolidation approval.

Not All Repayment Plans Will Work On Consolidated Loans

If you consolidate a Parent PLUS loan, a Direct PLUS Consolidation loan or a FFELP PLUS loan, then you will not be able to use the Income Based Repayment Plan (IBR). This is an important consideration when deciding whether or not you will want to consolidate these types of student loans. PLUS loans in general follow a different set of rules since parents and graduate students are the primary borrowers of these types of loans.

Student Loan Consolidation Repayment Options

Many people may think that they are stuck with a single fixed payment for a set number of years after they have consolidated their student loans. However, many of the most popular repayment options are still available even after people have consolidated their student loan debt into a Direct Consolidation Loan. These repayment options include the following:

  • Standard Repayment Plan
  • Graduated Repayment Plan
  • Extended Repayment Plan
  • Income Contingent Repayment Plan (ICR)
  • Income Based Repayment Plan (IBR)

Each option has its own unique set of criteria for how repayment is made and its own rules for determining eligibility. The common thing associated with all of these plans is that you will accrue more in interest the longer it takes you to pay off your student loans. There also may be little difference in your monthly payment from one plan to the next. This article takes a deeper look into how each repayment plan differs from the next regarding your monthly payment and your total accrued interest.

A Look at a Typical Student Loan Balance After Consolidation

Most research puts the average student loan debt for 2011-2012 at more than $25,000. The aggregate limit for Stafford loans for undergraduates is currently $31,000, and the maximum amount one can borrow on a Perkins loan is $27,500. Some students continue their education by attending graduate school and add to their total debt limit. For the purposes of this article,we will use the maximum borrowing limit from the Stafford loan of $31,000 as an average student loan debt. We will look at how the Standard Repayment Plan, the Graduated Repayment Plan and the Extended Repayment plan will affect your overall monthly payment and the total interest accrued over the life of your consolidated student loan.

A Look at a Typical Interest Rate After Consolidation

The interest rate on your consolidated student loans will be a weighted average of your fixed interest rates for the money you borrow each year using a Stafford loan. These interest rates change annually. Stafford loan limits for each academic year are illustrated in the table below. The corresponding fixed interest rate for the last three academic years is also illustrated.

Academic Year Borrowing Limit Subsidized

Interest Rate with Corresponding Academic Year

Unsubsidized
Year 1 $5,500 $3,500 5.6 % 2009
$2,000 6.8 % 2009
Year 2 $6,500 $4,500 4.5 % 2010
$2,000 6.8 % 2010
Year 3+ $7,500 $5,500 3.4 % 2011
$2,000 6.8 % 2011

The purpose of the table above is to illustrate the interest rates and borrowing limits for the subsidized and unsubsidized Stafford loans so that you can get an idea of what your weighted average interest rate would look like under consolidation. Each student will be different depending on the amount of subsidized and unsubsidized money borrowed, and the interest rate at which it was borrowed.

By estimating from the table above, we will use a weighted average of 5% interest for the purposes of our comparison.