What Is Loan Consolidation?
Student loan consolidation is the aggregation of several student loans with different interest rates and principle balances into one larger single loan. When loans are consolidated, a lender buys all the student's debt, which enables them to offer the student a new rate. Since the lenders have a lot of money, they can pay off the student's previous debt in full, which can allow them to offer lower interest rates than the student had initially. Consolidators are willing to do this because student debt is a type of debt that is fairly safe, as college graduates earn more on average than non-grads, and student debt is very difficult to avoid or get rid of, even in the event of bankruptcy.
When to Consolidate
The time when most students consolidate their loans is soon after graduation, sometime before they actually have to start making payments on their loans. (There is usually a 6-month grace period before loan payments have to be made.) Consolidating before any payments are made allows the student to reap maximum benefit from the consolidation. It is also a good time to consolidate if interest rates have fallen or if a student has variable interest loans and the consolidated interest rate is fixed and low. When interest rates fall, consolidating can allow the student to lock in his loans at a lower fixed rate. Changing variable rates into fixed rates through consolidation can prevent interest payments from increasing in the event that interest rates start to rise.
Benefits and Drawbacks of Consolidation
The primary benefit of loan consolidation is that it can allow student borrowers to pay less overall interest on their loans. It can also protect them from the volatility of payments involved with variable interest rates. Another benefit of consolidation is that it turns several payments owed to different lenders into one payment. This means that the borrower only has to worry about writing one check each month, which simplifies repaying the loan, and makes it less likely that the student will forget a payment.
There are several potential drawbacks to consolidation as well. For once, federal student loans offer very low rates, and consolidating them with higher rate private loans can result in an overall higher rate for the federal loans. Also, by consolidating, the student can no longer make over-payments of specific loans to get them paid off quicker. It can be a psychological victory to get a whole loan paid off even if it is a small one--a huge consolidated loan can make it feel like payments are just small drops in a very large bucket.
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