Reduce your Student Loan Payment

If you need financial aid to help pay for college, you’ll probably have one or more federal education loans. One common financial strategy to deal with multiple loans is to consolidate them into a single loan. Students commonly consolidate their federal loans together and consolidation loans are also available for privately funded education loans.

Good reasons to consolidate student loans

The consolidation process pays off all of your existing loans in full and replaces them with a single loan of equal value. Consolidation is a smart idea for improving your credit score because it shows that you have successfully paid off a series of loans while simultaneously reducing the number of your loans, both of which improve your credit score.

Another benefit of loan consolidation is that it allows you to make just a single monthly payment rather than writing multiple checks for your several loans. The monthly payment may also be reduced, making it easier to make each payment.

However, reducing the size of your monthly payment will mean extending the term of the loan; thereby increasing the total amount of interest paid over the lifetime of the loan. Extending the life of the loan in exchange for smaller monthly payments makes financial sense for some people, but try not to do it if you can afford it.

Interest Rates for Consolidated Loans

The interest rate on your consolidated loan will be a weighted average of the interest rates on the loans being consolidated. The new interest rate will also be rounded up to the nearest 1/8 of a percent, but will usually be capped at 8.25%.

Here’s a simple example:

Let’s say you have two Stafford loans, each with a rate of 6.8%. Since both loans have the same interest rate it is not necessary to create a weighted average. The new interest rate will be 6.8% rounded up to nearest 1/8 of a percent; in this case 6.875%. Your new interest rate is only slightly higher.

Another example:

This time you have two different kinds of loan, each with a different interest rate. You have a Perkins loan for $5,000, which has a rate of 5%, and Stafford loan for $10,000, which has a rate of 6.8%. The new interest rate will be a weighted average of the two loans:

                               ($5,000 * 5.0%) + ($10,000 * 6.8%) = 6.2%
                                               $5,000 + $10,000

This rate is then rounded up to the nearest 1/8%; in this case 6.25%.

When you consolidate loans with different interest rates, the weighted average will always be between the initial interest rates. This new rate may be lower than the highest of your interest rates, but it is also higher than that of your lowest rate.

Your new weighted average interest rate will not save you money; you will still have to pay the same amount of interest over the lifetime of the loan. You will also pay a small amount for consolidating and the rounding up of the rate. You will however have the benefits of making only one monthly payment and improving your credit score by paying off your preexisting loans.

Other Things About Loan Consolidation

In general you should not consolidate private student loans with federal student loans. They should be consolidated separately. This is because federal consolidation loans have lower interest rates and more benefits than privately consolidated loans.

New legislation that went into effect on July 1st, 2006 prevents students from reconsolidating their education loans while still in school. Students can now only consolidate their education loans during the grace period or after the loans enter repayment period.

You can consolidate your federal or private loans with any lender, but most private lenders will require a minimum balance before they will consolidate your loans. The minimum varies among lenders and can range from $5,000 to $10,000.

Federal education loans, including consolidation loans, do not have a prepayment penalty. You may pay back part or all of a federal education loan at anytime without paying a penalty fee.

Interest rates of privately consolidated loans are set by the lender, not by the federal government. There are many private lenders that will consolidate your privately funded education loans; some well know lenders include:

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