When you're overwhelmed by the weight of your loans, including student loans and other personal debt, debt consolidation can lighten the burden. However, that doesn't mean that you can immediately consolidate all of your debts under a single umbrella. Take a look at how you can manage your debts more effectively, whether that means consolidation or improving repayment options and remember that debt reconsolidation won't fix it all on its own. If you don't fix your spending habits, you can end up with double the trouble: a debt reconsolidation loan and credit card debt.
"Smart" Consolidation
Debt consolidation isn't a one-size-fits-all process. There are several factors to take into account, including many facets of your individual situation that may influence your payment or repayment needs. The goal of smart consolidation is to secure a lower average interest rate and simplify the repayment process. If your debt consolidation efforts don't achieve those goals, it may not be the right choice for your needs.
Federal Student Loans
Federal student loans come with a number of protections and supports. When you consolidate those loans under a private third-party lender, you lose all of those protections. That includes:
- Access to Public Service Loan Forgiveness
- Income-Driven Repayment Plans (IDR/SAVE)
- Disability discharge of those loans
In general, you should only refinance federal loans if you are 100% certain you will not need those protections. For most people, it's well worth leaving them under the federal account and working with your lender to achieve a lower payment rate or extended time that fits your budget and plans for the future.
Why You Might Consolidate Your Loans
There are several reasons you might choose loan consolidation.
- Lower Interest Rates: Interest rates can change dramatically over time. Not only that, as your credit improves, you may be able to secure a lower interest rate than you did when you first secured the loan. Furthermore, some loan consolidation offers may be better than higher-interest loans.
- Payment Simplification: Instead of making multiple payments over the course of the month, you can simply make one payment, one time. This can make it easier to handle your budget and prevent you from missing payments.
- Lower Payments: If you're struggling to make the current payments on your loans, consolidating loans may create lower payments.
This strategy is highly effective for many people, allowing them to better manage debt and decrease financial challenges. However, you shouldn't consolidate to get a lower monthly payment by extending the term. Turning a 5-year loan into a 15-year loan, for example, can result in significantly increased interest costs over the life of the loan.
Navigating Loan Consolidation
There are several strategies you can use to consolidate your loans. The right choice for you can depend on your available credit and the strategy you want to use to pay down debt.
Strategy 1: Managing High-Interest Debt
Some types of debt, like credit cards, have high interest rates that can leave you paying much more than the initial cost of a purchase. A lower-interest personal loan (8-10% interest) can help you pay off credit cards (20-25%) much faster, and at a considerably lower interest rate.
Strategy 2: HELOC (Home Equity Line of Credit)
A HELOC can provide a significantly lower interest rate for homeowners by allowing you to get a loan backed by the equity you have in your home. However, it does come with a substantial warning: if you default, you lose the house.
Strategy 3: Refinancing Private Student Loans
If you have private student loans, which already lack federal protections, refinancing them into a single new loan with a lower fixed rate is almost always a smart move if your credit score has improved since graduation.
Strategy 4: Refinancing Federal Student Loans: The Direct Path
A "Direct Consolidation Loan" (through the government) combines federal loans into one payment but does not lower your interest rate. Instead, it takes the weighted average. However, it is often a necessary first step to make older loans eligible for PSLF or IDR plans.
Is Reconsolidation Right for You?
Loan reconsolidation isn't for everyone. If you have high-interest private debt and a good credit score, it can help reduce your interest rate and costs. On the other hand, if you're pursuing PSLF or have precarious income, you may want to stick with the federal options and make sure you remain eligible for all those benefits. If you're ready to learn more about your loan reconsolidation options, reach out to us at HEFCU today.
Image credit: // Shutterstock // P Stock
