Right now this year’s crop of college graduates is being bombarded with the student loan consolidation mantra.
“The smart thing to do is consolidate your student loans…Consolidate Your Student Loans…CONSOLIDATE YOUR STUDENT LOANS.”
Not without good reason. Bunching all of your loans into one big pool can allow you to find a lower interest rate and a lower monthly payment through longer terms. However, the topic of student loan consolidation is top heavy with proponents; there are equally good reasons why you shouldn’t consolidate your student loans.
You Can’t Free Up Monthly Income Until the Last Payment
The biggest reason why consolidation can be a bad idea is that you agree to a large fixed payment and that payment won’t be reduced until you have made the very last payment. Having a number of different loan balances gives you flexibility and the option to decrease fixed debt costs.
Let’s say you have three loans totaling $328 per month; the individual payments are $65, $98 and $165. If you are diligent and pay off the loan with monthly payments of $65 early, you’ve just lowered your monthly fixed expenses to $260. That extra money should be used to help pay off the other loans, but if for some reason your budget is hit with an emergency, you’ve lowered your debt commitments.
Now, let’s say that the $65 and $98 payments have 10-year terms and the $165 a 20-year term. Without any extra payments at all, you’ll cut your fixed expenses in half after ten years. On the other hand, consolidation might offer to extend the terms of all loans to 20 years in exchange for a payment of $280, but without any extra payments, you are committing yourself to the same fixed cost for 20 full years.
You Know What Your Finances are Now and Don’t Know What They Will Be in a Decade
Having the option to more easily reduce your fixed expenses is a powerful benefit and leads into another very important consideration. What if you can afford a higher payment right now? Is there a benefit to paying more now if it lowers your long-term expenses sooner? The answer is “yes.”
Whenever you take on long-term debt, you carry the risk of financial hardship if your income suddenly reduces. We all hope to see our income always increasing, but life doesn’t always work out that way. You can’t say at graduation that you will be making as much or more in 5 year, 10 years or up to 20 years.
You can lower your risks if you accept higher payments in the short-term for lower payments in the long-term.
Consolidation Locks You into One Big Loan for the Long-Term
What’s the likelihood that you could pay down $5,000 before ten years? The odds should be favorable seeing as a new car is about 4 times more money. Now, what’s the likelihood that you could pay down $30,000 before ten years? Definitely not as likely as the $5,000 right?
There’s a psychological aspect to having debt. Several smaller chunks of debt seem less daunting and more manageable than one giant bill. It’s a smoke and mirrors reality, but sometimes “feeling” like you aren’t being crushed by student loans is worth paying more money. That’s the whole idea behind the debt snowball strategy.
There are plenty of reason why you should consolidate your student loans: lower interest rates and lower monthly payments. However, I don’t think consolidation is always the right strategy. The question is, what works best for you an your family.