Partial Student Loan Consolidation Strategy

Michael Lux Blog, Consolidation, Lower Payments, Mailbag, Student Loans 0 Comments

If you have multiple student loans, there is always the temptation to treat them all the same.  While this one size fits all approach may work in some circumstances, often it falls short when trying to put together the optimal plan.  Because loans have different interest rates, terms, and repayment plans; things can get pretty complicated.  When it comes to refinancing your student loans, it is especially important to realize that it is not an all or nothing option.

Two readers, lets call them Jack and Jill, recently wrote us with questions about consolidating a portion of their loans.

Jack writes:

I am just starting to look into loan consolidation (been paying for 5 years though) and had a question regarding the benefits, if any, of consolidating all, or just a portion of my $70,000 in loans. As a background, I have both private and federal loans. Additionally, I have high and low interest rates in each. My loans are through three providers. The 1st provider is a $5,000 private loan at 3.25%. The 2nd provider includes private loans of $14,500 (2 loans) at 7.75% and $32,000 (3 loans) at 3.25%. The 3rd provider includes federal loans of $1,500 at 2.30% and $17,000 (6 loans) at 6.8%.

My question to you is in applying for consolidation should I only have them (looking at SoFi and DRB) consider the high interest loans, or is there a benefit (other than convenience) to looking at total consolidation? I do work as an engineer for a not-for-profit municipal electric company, so I understand that there is some potential for federal loan forgiveness. However, the 3rd provider estimates payoff by 2020 (or so it says on my loan overview page, though I am skeptical) and that is how long it will take me to get to the 10 year forgiveness threshold anyways. Ideally I would like to lower my monthly payment, while minimizing total payback costs. Any advice you could offer would be greatly appreciated.

Along the very same lines, Jill writes:

I’m considering refinancing my student loans and I’m not sure what the best option would be because I have a mix of private and federal loans. I am in a somewhat unique situation because I have two undergraduate degrees, obtained separately, and loans from both schools. I consolidated my first set of loans into a FFEL loan which has a balance of $7,700 and is currently fixed at 1.88%. I do not plan on changing this loan or including it in the refinancing of my other loans.

I currently work in healthcare. I have checked into the public service student loan forgiveness, but as I have FFEL loans and not Direct loans, I do not qualify unless I consolidate them into a Direct Consolidation Loan. I have already been paying on these loans for about 7 years and I’m looking to lower my interest rate. My private loans are actually at a much lower interest rate than my federal loans. I have about $14,000 in private loans at a 3.5% interest rate. I would be fine with leaving those as is because the interest rate is pretty good. My federal loans total $31,000 and have an interest rate of 6.55%. I know you advocate not combining federal and private loans, but do you think it would be better for me to refinance my federal loans for a lower interest rate? I have excellent credit; no late payments, a credit score over 750 and a credit history of almost 12 years. I’d love to hear your thoughts on how best to lower my interest rates.

Most people probably find themselves in situations similar to Jack and Jill.  They have a mix of private and federal loans, and interest rates ranging from pretty good to awful.  Complicating things for Jack and Jill is the issue of student loan forgiveness in the possible distant future.  If they consolidate their federal loans on the private market, they lose forgiveness options, but they get lower interest rates starting immediately.

Getting Started

To untangle the options and issues at play here, step number one is to go over the ground rules.  As both these readers have noted, consolidation is not an all or nothing option.  This means that you can leave your low interest debt alone, while reducing the high interest debt.  Jack does point out that there is a convenience to “total consolidation” because you only have to deal with one company going forward.  Whether or not you should do this comes down to the math.  If one of your loans gets a higher interest rate, figure out how much more you will be paying each month in interest.  Is the larger payment worth the added convenience?

Next be certain you have your federal and private loans sorted out.  The perks with federal loans are big, so you don’t want to give them up unless you are absolutely sure.  This is especially important to keep in mind because there is no way to undo a student loan consolidation.  Once the individual loans get combined into the big new loan, you are stuck with the consequences.

Should I consolidate my federal loans?

This is a topic we have previously addressed in some detail, but there is a fairly easy way to engage in this analysis.

Put together a list of all the perks of the federal loans that apply to you.  Public service forgiveness is an option for Jack and Jill, so that goes on the list.  Losing a job is a possibility for anybody, so having the option of Income Based Repayment should be on every list.  Once you have researched all the benefits, it is time for some math.

If you have the option to lower the interest rate, calculate how much you will save each month with the lower rate (note: focus on the interest savings rather than the actual payments because repayment length can skew the data).  Once you know how much it costs you to keep the federal protections in place it is time for self assessment.  If you can save a ton of money by giving up programs you will never use, consolidation makes sense.  If you are not saving much money, and the protections of the federal loans might come in handy one day, keep your debt with Uncle Sam.

For Jack and Jill, this analysis will weigh heavily on the student loan forgiveness aspect of the loans.  If the public service forgiveness can result in a huge chunk of debt disappearing after ten years, don’t mess with the loans.  If there won’t be much of anything to forgive, locking in a lower interest rate may make sense.  Whatever you do, be careful to make sure that you don’t actually spend more money chasing forgiveness than you would have if you just choose to pay off the debt.  It can happen.

Deciding what to refinance…

If you decide to try your hand at consolidation, deciding exactly what loans to use might seem like a difficult question.  Fortunately, there isn’t anything challenging to putting together this plan.

Step 1: Figure out which companies you will be applying to.

We have reviewed a whole list of private student loan consolidation companies, and they seem to be popping up all the time.  The good news is that the only limitation on the number of places you can apply to is the amount of time you are willing to spend.  Whether you apply to one company or six, the hit to your credit score is the same, so it really pays to shop around.  That being said, some companies may not offer rates that would help you, others you may not want to do business with.

Step 2: For each company, determine your best possible interest rate.

This step isn’t quite as easy as it sounds.  You cannot just look at the lowest advertised price an assume that number applies to you.  This is especially true if you are looking for something along the lines of a 15 or 20 year fixed-rate loan.  With most lenders, the lowest advertised price is for a short-term variable rate loan.

It is hard to figure out who will get the best rate for a given type of loan, so if company X says that the starting rate for the type of loan you want is 4.5%, you can hope for the best use that as your starting point.

Step 3: Compare your interest rates against what you could get on the private market.

Some loans are not worth consolidating.  It may be because you don’t want to give up the federal benefits, or it could be because you won’t be able to beat the interest rates.

For example, Jill has a loan at 1.88%.  This interest rate is fantastic and not likely to get beaten by a consolidation company.  She also has a loan at 3.5%.  That rate may or may not be better than the best rate she can hope for when applying.  Other high interest loans, such as Jack’s 7.5% loan can definitely be beaten.

Step 4: Apply to consolidate any loan that might improve.

If there is zero chance that you have interest in consolidating a loan, leave it off of you application.  Everything else gets added.

The reasoning behind this is simple.  Just because the loan is on the application to be consolidated does not mean that you have to include it in your consolidation.  It just means you are considering it.  Once you see the terms and conditions, including the interest rate that you actually qualify for, you can make a final decision.

However, if you do apply to have a loan refinanced and eventually decide not to include it in the final consolidation, be sure that your lender makes the necessary changes.  Check and double check to prevent the loan from accidentally being included.

One last suggestion…

There is no approach that works best in every situation.  The important thing is to collect all the facts and to apply them to your situation.  An excel spreadsheet and a second set of eyes are both great tools to make sure that you are not missing anything.

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