Why You Shouldn’t Consolidate Your Student Loans

February 2, 2012
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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.

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34 Responses to Why You Shouldn’t Consolidate Your Student Loans

  1. shanendoah@The Dog Ate My Wallet on February 2, 2012 at 1:39 am

    I think there are a lot of considerations involved. I consolidated my undergrad loans back in 2004/2005. My interest rate is fixed at 3.5% (which considering I got my loans in the mid 1990s, was a break of around 5%).
    But for me, the main argument for consolidating for me would be if I had multiple loan servicers and one was awful and the other was wonderful. (I had this recently, and I looked for ways to get my undergrad loan servicer to buy my grad loans. But then my grad loans were sold to someone else and things are fine now.)
    I think a lot of this is going away now that most federal student loans are direct instead of through lenders, but having a good loan servicer can make as much or more of a difference in payment than the flexibility of multiple loans.

    • Shaun on February 2, 2012 at 2:06 am

      2004/2005 was a good year to have student loans no?

      It’s a good point you bring up. Although, I sincerely hope that you can weed out bad loan companies before borrowing. I do understand that it isn’t always possible to do so.

  2. maria@moneyprinciple on February 2, 2012 at 8:03 pm

    Very sound advice, Shaun. It also goes beyond student loans – I suppose similar considerations can apply to all consolidation. Except if people already have a clear plan for overpayment and have a consolidation loan that allows is without penalties. In such case it may be ‘automation’. Or am I worng?

    • Shaun on February 4, 2012 at 2:02 am

      Thanks for pointing that out Maria. I had not actually thought of how this can apply to any consolidation. I was thinking the other day about how I had decided not to consolidate and that I was someone who needed the flexibility of lowering monthly expenses.

  3. Charles on February 2, 2012 at 9:26 pm

    Yeah, dave ramsey actually says that reducing debt is 80% mental and 20% doing. sometimes even though it may not be the most cost efficient method, having small mental victories will push you forward. I think that makes sense to me.

    • Shaun on February 3, 2012 at 11:15 pm

      I’m a long-term oriented person, so the psych benefit isn’t quite as big for me as the flexibility.

  4. funancials on February 3, 2012 at 1:13 am

    I’ve gotten a lot of offers to consolidate but haven’t given them much thought. Right now I’m paying 2-4% and figure it can’t get much better. I’ve considered paying them off but I can get better returns elsewhere.

    • Shaun on February 4, 2012 at 2:05 am

      I’m glad you mentioned the investment part. I think starting investing when you are young, is key, perhaps more than paying down debt (at first).

  5. [...] at Smart Family Finance suggests that student loan consolidation is not a good move.  He makes a very good mathematical argument.  I’m always a believer in keeping your [...]

  6. 20's Finances on February 3, 2012 at 1:15 pm

    Nice argument – I like the idea of minimizing future commitments. It definitely is situational, but like you pointed out, not as clear cut as many portray it.

    • Shaun on February 4, 2012 at 2:06 am

      To this day I still hear about consolidation. I understand that it is a good idea for many people. But, I think that they don’t understand both sides to the decision.

  7. Suba on February 3, 2012 at 7:18 pm

    If you consolidate do they also add in a pre-payment penalty? I have never consolidated anything so not sure if that is true, but I was told by a friend that some loans do this. If that is true, that is a big reason for me to not consolidate.

    • Shaun on February 4, 2012 at 2:07 am

      Great point Suba. I can totally see that happening. I know government loans (which is all you can usually consolidate) do not have early payment penalties.

  8. Dr Dean on February 4, 2012 at 1:14 am

    Suba’s question about a pre-payment penalty is the same one I had. As you point out, there are several things to consider when deciding about consolidating any loan.

    • Shaun on February 4, 2012 at 2:07 am

      Yeah. That certainly could be a big consideration. Perhaps a second post???

  9. Jeremy @ Personal Finance Whiz on February 4, 2012 at 4:59 pm

    I’m against debt consolidation in almost all cases for this very reason. Having multiple small payments gives you much more flexibility than one large payment each month. The only way I would consolidate is if I could get a substantially lower interest rate.

    • Shaun on February 5, 2012 at 1:43 am

      I avoided consolidating my student loans and I’d be financially strapped right now if I had consolidated. I’ve paid off my private loans and it’s freed up some much needed cash on hand.

  10. [...] I consolidated my undergrad student loans, but my graduate loans remain separate. Smart Family Finance tells us why consolidating our student loans isn’t always a good idea. [...]

  11. Economically Humble on February 4, 2012 at 10:56 pm

    Another thing to remember is that there are many Federal loan repayment options out there for individuals in education and health related fields that end up working in poor or underserved communities. … the repayment options are very large too, upwards of $50K and more. The consolidated loans are not eligible.

    • Shaun on February 5, 2012 at 1:46 am

      Are you referring to debt forgiveness? Yet another great point. I may need to write this post up a second time for all the great things people have added.

      Thanks for stopping by!

      • Chris on June 29, 2012 at 10:30 pm

        actually all direct consolidated loans are eligible and you can also consolidate private loans to make them eligible

  12. Elizabeth @ Simple Finance on February 5, 2012 at 7:22 pm

    I have to agree with your very first commenter – like her, I consolidated my student loans (which were MASSIVE) in 2005 to a rate of just 1.25%. You can’t beat that. I think the decision whether or not to consolidate depends on a number of factors, including how many loans you currently have, the interest rates and the principle.

  13. [...] out of the attic and see what the coins could possibly be worth.”Smart Family Finance posted Why You Shouldn’t Consolidate Your Student Loans – “Bunching all of your loans into one big pool can allow you to find a lower interest [...]

  14. Super Frugalette on February 6, 2012 at 5:44 am

    We consolidated our loans and are now under IBR for a whole host of reasons. I think it really depends where you are in your life – age wise, what is your current income and what is your future income potential as well.

  15. Penny Stock Blog on February 7, 2012 at 12:59 am

    I was recently talking to someone I know at work about higher education’ she has sixty thousand dollars of student loan debt. I asked here if see thought college should be free and here response was no that it would be a bad idea because than it would lose much of its high regard if it were free. I tend to agree. I don’t know a lot about higher education. I taught myself to type on the computer. Although I believe that some education beyond high school is useful. I believe that society places to much weight on the four year degree. She commented that here husband was working at a retail store and the management was impressed enough with his job performance that they enrolled him in a management training program when they checked their personal records they found that he did not have a college degree so they unenrolled him and at that point he left the company. The Idea was that higher education is the great equalizer as far as socioeconomics go but in many cases today it has become the great unequalizer. Another guy I know used to work for ford motor he told me that he applied for a job as a department head at the plant but he was rejected not because of a lack of ability he was qualified they told him that he did possess the skills and ability to handle the job but he lacked a college degree. We have now created a class structure based on these varying degrees’ high school’ associate’ bachelors’ masters’ or doctorate. Now we have a situation where because of the inflation in higher education costs the likelihood of someone at the middle of the totem pole as far as family income goes has less ability to qualify for and meet the financial qualifications of higher education unless their willing to go deeply into debt or unless their very bright which would mean they could qualify for a scholarship’ what about everybody else. What if the standard for getting that better job becomes not the bachelors but the masters degree this will only increase the inequality even more leaving only the rich and affluent to take advanage of higher education and qualify for all the better jobs. All this system of things does is create even more inequality than we already have. This is anything but a positive development.

  16. John | Married (with Debt) on February 7, 2012 at 7:51 pm

    It’s funny, I always hear this argument when it comes to 15yr vs 30 year mortgage, but I’ve never heard it for student loans. Interesting points here, and well presented.

    • Shaun on February 7, 2012 at 11:39 pm

      Thanks John. I myself did not consolidate and not doing so has proved the right decision thanks to the flexibility it offers.

  17. [...] presents Why You Shouldn’t Consolidate Your Student Loans posted at Smart Family Finance , saying, “There are plenty of reason why you should [...]

  18. Amanda L Grossman on February 18, 2012 at 9:53 pm

    I consolidated all of my student loans except for one private one with a high interest rate (it would have increased the interest rate by several points on the bulk of my other loans). I am so happy that I did! I paid off the higher interest rate one more quickly, and then paid off the other one. The interest rate on the bulk was an amazing 2.65%, and then 1.65% after 36 months of payments.

  19. [...] Family Finance : Why You Shouldn’t Consolidate Your Student Loans – There are plenty of reason why you should consolidate your student loans: lower interest [...]

  20. Frugal Confessions on February 20, 2012 at 10:01 am

    [...] Why You Shouldn’t Consolidate Your Student Loans at Smart Family Finance: I consolidated my $36,000 of student loans at 2.65% interest back in 2006. [...]

  21. Best of Money Carnival #143 | Market Research on February 20, 2012 at 3:04 pm

    [...] Why You Shouldn’t Consolidate Your Student Loans at Smart Family Finance: I consolidated my $36,000 of student loans at 2.65% interest back in 2006. [...]

  22. [...] Until then, we’ve got the overwhelming problem of student debt to deal with. Shaun at Smart Family Finance knows that an easy fix is to consolidate your loans, if by “easy” you mean [...]

  23. [...] why you shouldn’t consolidate student loans, read more to find out why. Shaun presents Why You Shouldn’t Consolidate Your Student Loans posted at Smart Family [...]

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