Why consolidating your student loans might do more harm than good
This is last in a three-part series on how to consolidate your student loans. Part two can be read here.
Student loan consolidation is being offered as the quick and easy "one-size-fits-all" solution to many student debt related challenges.
Yet, the term consolidation can actually refer to one of three completely different things: federal student loan consolidation, private student loan consolidation and overall debt consolidation.
Each type of consolidation has its unique benefits — and drawbacks — and should be entered into only with thoughtful consideration, and the guidance of a trusted and seasoned professional.
Overall debt consolidation
Overall debt consolidation is a type of "financial relief" resource that is commonly and often aggressively marketed to student loan borrowers, just as federal student loan consolidation and private student loan consolidation are.
Overall debt consolidation moves all of your existing debt into a single loan, and applies an interest rate to the total balance that is ideally lower than the average interest rate of all of the outstanding credit.
Both federal and private loans can be included in these types of consolidations. However, including student loans within this type of debt consolidation is usually not a good idea for three significant reasons.
1. You will miss out on generous federal student loan repayment assistance, including income based repayment, deferment and forbearance.
Borrowers have at their disposal a wide array of repayment assistance. For federal loans alone, there are well over a dozen types of repayment assistance plans (such as deferments, forbearance, income based repayment plans and interest only repayment plans) that are presently available.
However, when borrowers choose to include federal student loans in a consolidation with other outstanding debt (e.g. credit card debt, car lien) they miss out on the many forms of repayment assistance that are generously made available exclusively for their federal student loans.
In comparison to credit card lenders and mortgage lenders, student loan lenders, both private and federal, offer the most flexible and extensive repayment assistance to their borrowers. This certainly should not be dismissed.
2. The borrower will likely end up paying the debt consolidation lender more than the amount they could have negotiated with their creditors themselves.
Borrowers often don't realize that since they are not dealing with the collection agency or lender directly, they could have negotiated an even better outcome had they had spoken with their lending company directly.
Moreover, working with a debt consolidation company takes away the greater control a borrower could have had over outstanding debt. In fact, when borrowers put a third party in charge of negotiating their debt repayment, they need to beware that this third party might not have their best interest in mind.
Some debt consolidation lenders even offer consolidation to those with defaulted student loans. They'll negotiate a settlement with the lender, and then charge the defaulted borrower for their services.
In this scenario, the debt consolidation lender sets up an escrow account for the borrower — which, in these circumstances, is generally not a creditworthy applicant — to pay the debt off slowly while the debt consolidator negotiates the settlement.
3. Federal student loans already offer the option of rehabilitating loans, if the borrower makes nine consecutive payments.
Once a loan is rehabilitated, the borrower's loan is now in good standing, and the borrower once again qualifies for all the available federal student loan repayment assistance. This includes deferments, forbearance, income based repayment, pay as you earn and income sensitive repayment.
However, if borrowers choose to consolidate with a debt consolidation lender, they’ll miss out on this borrower-friendly caveat.
If you choose to consolidate
Now that you are apprised of all the above information, you may decide not to rush into overall debt consolidation.
No matter what type of student loan consolidation you consider, understanding your options and the impact that any type of consolidation will have on your loans and entire financial landscape is crucial when trying to make the best decisions for your financial future.
Consolidation is not a quick-fix solution that meets everyone’s needs. Make sure you speak with a trusted professional who can guide you to the best possible decision with regards to repaying your student loans.
Jan Miller is a student loan consultant and founder of Miller Student Loan Consulting. EMAIL: firstname.lastname@example.org
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