If you have a large amount of debt, loan consolidation may be your answer. Find out what it means to consolidate a loan, the risks and rewards involved in it, the different types of student loan consolidation and how to apply for each.
Meaning of Loan Consolidation
Loan consolidation means using one larger loan to pay off several small loans, usually to get a lower interest rate or lower monthly repayment amount.
Types of Loan Consolidation
The two types of loan consolidation are secured and unsecured.
A secured loan requires some sort of collateral, such as your home, while an unsecured loan requires no collateral but are harder to get. You’ll typically need a high credit score to get an unsecured loan. That’s why loan consolidation can be risky. But it still may be the right option for you.
Can I Consolidate Other Types of Loans?
You can also consolidate your credit cards, your car loans or signature loans. You will just need to take out a larger loan and use that money to pay off your other debts. Before you consolidate credit card loans, car loans, or any other type of private loans, be sure that you will actually end up saving money in the long run.
Many banks will specialize in consolidation loans, and you may get loan offers in the mail that offer consolidation loans at low rates. If you receive these, read the fine print and look for reviews online since many of the interest rates are ranges, not guarantees. You should also research the company before signing on the dotted line.
What Are the Risks of Loan Consolidation?
A few things to keep in mind before you consolidate your loans. First, know the difference between an unsecured loan and a secured loan. The latter is riskier because it is tied to a larger asset, (like your car or home), so you risk losing that property if you default on the loan.
Second, you should always consider the lower monthly payment of a potential loan consolidation versus the interest rate. Be sure that loan consolidation is the most financially beneficial option for you, and don’t just do it because it’s easier to have only one big payment a month.
There’s also the risk that loan consolidation won’t actually help you get out of debt. Loan consolidation will often free up a little bit of extra income, and pay off some credit card balances. However, this does not mean that you should continue to spend money at the same rate that you were previous to the consolidation. It’s important to look at your financial behaviors carefully before you take this step.
What Are the Benefits of Loan Consolidation?
Many people especially international students consider doing loan consolidation because it allows them to lock in the loans at a lower interest rate and gives them a set payment. It is important to consider how much lower the interest rate is and whether or not it is a permanent rate before you take this step.
While loan consolidation can be a smart move, it’s only beneficial long-term if you stop using your credit cards or change your habits so you do not continue to run up debt. You also need to choose a good consolidation loan with solid terms and a set interest rate.
Will Loan Consolidation Fix My Debt Problems?
Most importantly, loan consolidation does not address the spending habits that got you into debt into the first place. It is important to address those problems and stick to a budget in order to change your financial situation, whether you decide to pursue a loan consolidation or not.
You need to address the real issues in your spending habits in order to get ahead financially. The first step is to get on a budget so that you can stop overspending. Only then will you be able to start working toward your financial goals.
Types of Student Loan Consolidation
We have two types of student loan consolidation; Federal and Private. Private consolidation is often referred to as refinancing. The two are different from each other in the following ways;
Federal student loan consolidation combines multiple federal loans into a single federal loan through the Department of Education. You may need to consolidate to be eligible for some federal loan repayment programs, but federal consolidation won’t lower your interest rate. It may lower your payments by extending them.
Student loan refinancing, which is also called private student loan consolidation, is a financial move you do through a private lender. If you qualify, you can save money by getting a lower interest rate.
How to Consolidate Private Student Loans
Private student loan consolidation, or refinancing, means replacing multiple student loans — private, federal or a combination of the two — with a single, new, private loan. You’ll save money if your new loan has a lower interest rate.
Your financial history — including your credit score, income, job history and educational background — will dictate your new interest rate when you refinance. You typically need a credit score at least in the high 600s to qualify, and rates range from around 2% to more than 9%.
Requirements for Refinancing
you must have made at least a few on-time student loan payments after leaving school.
Good or excellent credit, generally defined as credit scores of 690 or higher.
Have a stable job.
Access to a co-signer with those characteristics, if that doesn’t sound like you.
Note; Refinancing federal student loans into a private loan means losing consumer protections specific to federal loans. Those include the option to tie payments to income and opportunities for loan forgiveness.
Like the federal government, private companies offer the option to consolidate multiple student loans into one. But unlike the federal government, they can consolidate both federal and private loans.
The goal with this process is not only to get the ease of a single payment, but to receive a lower interest rate based on your financial history.
Use a consolidation calculator to compare monthly payments under three different scenarios: federal student loan consolidation, private student loan refinancing and income-driven repayment plans.
Federal Student Loan Consolidation
Federal loan consolidation doesn’t have a credit requirement, and it offers the benefit of a single loan bill and potentially lower payments. But it’s only for federal loans, and it won’t cut your interest rate.
Requirements for Federal Loan Consolidation
You need to consider federal consolidation if you;
- Need to consolidate to be eligible for income-driven repayment or public service loan forgiveness. This is the case if you have Federal Family Education, Perkins or parent PLUS loans.
- Want a single federal loan payment, but don’t need it to be drastically lower
- Are in student loan default and want to get back on track
- When you consolidate federal loans, the government pays them off and replaces them with a direct consolidation loan. You’re generally eligible once you graduate, leave school or drop below half-time enrollment. Consolidating your federal loans through the Department of Education is free; steer clear of companies that charge fees to consolidate them for you.
When you consolidate federal loans, your new fixed interest rate will be the weighted average of your previous rates, rounded up to the next ⅛ of 1%. So, for instance: If the average comes to 6.15%, your new interest rate will be 6.25%.
Additionally, you’ll get a new loan term ranging from 10 to 30 years. Your repayment term will generally start within 60 days of when your consolidation loan is first disbursed and will be based on your total federal student loan balance, among other factors.
How to Consolidate Federal Student Loans
Log in to studentloans.gov and click on “Complete Consolidation Loan Application and Promissory Note. ” You’ll need to finish the application in one session, so gather the documents listed in the “What do I need?” section before you start and set aside about 30 minutes to fill it out.
- Enter which loans you do — and do not — want to consolidate.
- Choose a repayment plan. You can either get a repayment timeline based on your loan balance or pick one that ties payments to income. If you pick an income-driven plan, you’ll fill out an Income-Driven Repayment Plan Request form next.
- Read the terms before submitting the form online. Continue making student loan payments as usual until your servicer confirms consolidation is complete.