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7 Reasons Not to Consolidate Your Student Loans

Matthew Frankel, CFP, The Motley Fool

Consolidating student loans has its advantages, but it isn’t the right move for everyone.  

Image source: Getty Images.

There are certainly some benefits to student loan consolidation. Most obviously, you’ll only have one monthly payment to worry about, and if you have strong credit, you might be able to find a lower interest rate when consolidating or   refinancing your student loans .

However, student loan consolidation has its drawbacks as well and isn’t a smart move for everybody. Here are seven reasons why you may be better off leaving your student loans as they are.

1. Repayment options may not be as flexible

If you use a   private student lender  to consolidate your loans, you’ll generally be committing to one repayment schedule for the entire term of the loan. Federal student loan borrowers can choose a standard 10-year repayment plan or an extended term, but also have the ability to take advantage of unique and potentially money-saving options such as the Pay As You Earn plan or other income-driven repayment options.

If you obtain a federal Direct Consolidation Loan, you are still eligible for these alternative repayment plans. However, it’s important to note that by consolidating, you’ll lose any credit you’ve already earned toward income-driven repayment plan forgiveness. For example, the Pay As You Earn plan offers forgiveness of any remaining balance after 20 years of on-time payments. So, if you’ve already made several years’ worth of payments under the plan, you’d effectively be starting the clock over.

2. You may lose the ability to get a deferment or forbearance

Private student loan consolidation  has become much more prevalent over the past few years. However, it’s important to realize that there are some hardship options (deferment and forbearance) that aren’t likely to be offered by a private lender. These allow you to postpone payments if you fall on hard times financially, so if you don’t have a rock-solid source of income, you may want to think twice before losing this option.

3. You can’t selectively repay your loans

When you have several individual student loans, you have the ability to pay down your highest-interest loans faster. As a personal example, I have separate student loans for every semester I was in school. These loans have interest rates ranging from 5.75% to 6.75%. When I want to pay extra towards my student loans, I have the ability to apply the payment towards the higher-rate loans in order to maximize my interest savings. If I were to consolidate my student loans, I would lose this option.

4. You are within your grace period

With most student loans, you have a six-month grace period after leaving school before you need to start repaying your loans. Consolidation loans have no such window, and generally require repayment starting about two months after the loan is approved. In other words, if you just graduated and apply for a consolidation loan, you need to be prepared to start making payments much sooner.

5. You’ve already been paying your loans for a while

When you consolidate your loans, your loan repayment term starts again, or could get even longer. Many borrowers are attracted to consolidating because it often translates into a lower monthly payment. However, you’ll end up paying your loans for a longer period of time, especially if you’ve already been paying on your loans for some time.

6. You work in public service or you’re a teacher

Federal student loans have some pretty generous forgiveness programs if you qualify. Teachers can apply for as much as $17,500 in loan forgiveness after five successful years of classroom teaching, and public service employees can apply to have any remaining balance forgiven after 10 years of on-time payments in a qualifying repayment plan. Private student loans typically don’t have any similar forgiveness programs.

Even if you decide to consolidate your loans through a federal direct consolidation loan, it’s important to realize that any progress you’ve made towards public service loan forgiveness (PSLF) will cause the 10-year clock to re-start.

7. Your student loans may have a lower interest rate than you can find elsewhere

If you apply for a consolidation loan with a private lender, your new interest rate will be based on factors such as your credit history, repayment term length, and your lender's currently-available interest rates. Your federal student loans have a fixed interest rate that is generally on the lower end of the spectrum, so there’s a good chance that you won’t find a better interest rate through a  private lender .

On the other hand, if you use a federal direct consolidation loan, a weighted average of your loans’ interest rates will be taken, and then adjusted upward by 0.125%. Although it’s a small difference, it’s important to be aware that you’ll pay slightly more interest by consolidating.

In addition, if you have any accumulated unpaid interest on the loans you’re consolidating, it will be added to the principal balance. So, your future interest will be calculated on a larger principal balance than before.

To reiterate, there are certainly some advantages to consolidating or refinancing your student loans. However, if any of these situations discussed here apply to you, you might want to think twice.

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