I have a question concerning consolidating my federal loans. I
have some that are subsidized and some that are unsubsidized. Can I
combine these at a lower interest rate? I have graduated from college
and will soon be starting to pay back my loans. My unsubsidized loans
are at 6.8% and subsidized are at 5.5%. I also have many DEAL loans,
a total of $25,000. Do you have any suggestions on how I
could save on these loans? They are at various interest rates.
— Denise G.
Consolidating your federal student loans may streamline repayment by
replacing several loans with a single loan and a single monthly
payment, but it will not save you money. Consolidation may have saved
borrowers money in the past, but it no longer does so.
Federal education loans made before July 1, 2006 had variable interest
rates. Federal consolidation loans could be used to lock in the
current interest rates on the variable rate loans since a
consolidation loan has a fixed interest rate based on the current
interest rates of the loans being consolidated. To the extent that
the borrower was able to lock in a low interest rate, this would save
money compared with the maximum possible variable interest rate. For
example, Stafford loan borrowers in 2005 could consolidate their loans
during the in-school or grace periods to lock in an interest rate of
2.875%, much lower than the 8.25% cap on the variable interest rates.
But federal education loans made on or after July 1, 2006 have had
fixed interest rates. There is no longer any opportunity to use
consolidation to lock in an interest rate, since the interest rates on
these loans are already fixed. The fixed interest rate on the
unsubsidized Stafford loan since July 1, 2006 is 6.8%. The fixed
interest rate on the subsidized Stafford loan depends on the academic
year in which the loan was originated, with loans made in 2006-07 and
2007-08 at 6.8%, in 2008-09 at 6.0%, in 2009-10 at 5.6%, in 2010-11 at
4.5% and in 2011-12 at 3.4%. (New subsidized Stafford loans in 2012-13
and subsequent years will be at 6.8%.) Your subsidized Stafford loans
are probably at either 5.6% or 4.5%, not 5.5%.
A federal consolidation loan has a fixed interest rate that is the
weighted average of the interest rates on the loans being
consolidated, rounded up to the nearest 1/8th of a point. The weighted
average will always be between the highest and lowest interest
rates. So while one could characterize the weighted average as
reducing the interest rate on the loan with the highest interest rate,
one could also say that the weighted average increases the interest
rate on the loan with the lowest interest rate. It is not like a
traditional refinance where one can get a new, less-expensive loan after
interest rates drop enough to make the refinance worthwhile. The use of
the weighted average in a federal consolidation loan does not
significantly change the overall cost of the set of loans being
consolidated.
Note that borrowers who consolidate their federal student loans often
choose an extended repayment term. While this may make the loan more
affordable by reducing the monthly payment, it does not save money
because it increases the total interest paid over the life of the
loan. For example, increasing the term on an unsubsidized Stafford
loan from 10 to 20 years cuts the monthly payment by a third, but more
than doubles the total interest paid (a factor of 2.18 increase).
A borrower might still want to consolidate their federal education
loans to simplify repayment. Some lenders offer unified billing, where
the borrower gets a single monthly bill for all their loans without
consolidating. But all of the borrower's loans have to be with the
same lender. Many borrowers graduating now have a mix of several types
of loans, including loans from the federally-guaranteed student loan
program (FFELP) and loans from the Direct Loan program, as well as
FFELP loans that were sold to the US Department of Education. These
loans cannot be serviced together, so consolidation presents the only
opportunity to get a single monthly bill. (Borrowers might also want
to consolidate their federal loans to get public service loan
forgiveness or to get access to certain alternate repayment plans.)
But there are also benefits to keeping the loans separate. If you have
several loans at different interest rates, keeping them separate
allows you to target the loans with the highest interest rates for
earlier repayment. (There are no prepayment penalties on federal or
private student loans.) You should always make the required monthly
payments on all your loans. But if you have some extra money, using it
to accelerate repayment of the highest interest rate loan first will
save you more money than if you accelerate repayment of a
consolidation loan.
For example, suppose you have $11,820 in 6.8% loans and $10,000 in
5.6% loans. A consolidation loan would have a 6.25% interest rate on
the combined balance of $21,820. (The loan balances in this example
were picked to ensure that the consolidation loan would have an
interest rate that would not change with the rounding up to the
nearest 1/8th of a point.) Assuming a 10-year repayment term with an
extra $50 a month prepayment, applying the extra payment to the 6.8%
loan saves about $121 more than applying it to the consolidation loan.
Since July 1, 2010, only the Federal Direct Loan program can consolidate
federal education loans. Visit loanconsolidation.ed.gov
or call 1-800-557-7392 (TDD 1-800-557-7395)
to consolidate federal education loans.
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