Consolidating your student loans is a major financial commitment. One thing that people often don’t realize is that consolidation is not an all or nothing proposition. In fact, only consolidating certain loans can often be very advantageous. The best way to illustrate this is a simple example:
One Possible Private Loan Situation
Suppose you have three student loans. Each loan has a balance of $10,000. Loan A has an interest rate of 9%, Loan B has an interest rate of 7%, and Loan C has an interest rate of 3%.
After reviewing a list of student loan consolidation companies, you learn that the best interest rate you can get is 5%.
The Question: Should I consolidate?
Many people make the mistake of thinking that combining all three loans is the best approach because you are still lowering your interest overall, so it is a smart move. Combining all three loans leaves the borrower with a $30,000 debt at 5%.
In reality, the smartest move would be to only consolidate the high interest loans and to leave the low interest loans alone. In our example, the borrower could have one $20,000 loan at 5% and one $10,000 loan at 3%. Doing this approach will help save a lot of interest over the years (the exact amount will vary depending upon how long it takes to pay off the loans).
A Note about federal loans
This is one area where federal loans work much different than private loans. If you combine your federal loans, it is done through the Department of Education. Interest rates are not determined based upon what you qualify for, instead, it is just a weighted average of all of your loans. This calculation policy means that a reduction of interest rate is not an option through federal government consolidation.