When it comes to paying off student loan debt, the struggle is real. There are several methods and strategies out there to help you pay it down faster, but this student loan hack is worth considering.
Student loan consolidation is a popular way to restructure student debt, but there are several ways to do it. And some of them will cost you instead of saving you money. So, before you take one more step toward consolidating your student loans, read on to learn how to do it the right way.
What is student loan consolidation?
“For most students, they graduate with four or five different loans,” says Robert Farrington, founder of The College Investor. “In many cases, these are all from the same lender, but sometimes they aren’t.”
For those who have multiple federal student loans, the Department of Education allows you to consolidate them into one loan. Not only does this process make it easier to manage your debt (you have just one monthly payment instead of several), but it can also qualify you for an income-driven repayment plan if the type of federal loans you currently have don’t qualify.
“This is also beneficial, in some circumstances, to qualify for forgiveness programs such as Public Service Loan Forgiveness (PSLF),” says Farrington. “For example, if someone has an older FFEL loan, they could consolidate it into a Direct Consolidation Loan, which would qualify them for PSLF.”
What happens when you consolidate a loan?
A Direct Consolidation Loan does not help you get a better interest rate. In fact, when you consolidate, your new interest rate will be the weighted average of the interest rates on the loans you’re consolidating, rounded up to the nearest one-eighth of a percent.
For example, say you’re single and living in California with an annual salary of $60,000. You can afford to pay $550 per month toward your student loans, and have two:
- $20,000 with a 5.5% APR
- $35,000 with a 7.75% APR
If you consolidate the two loans together, the new loan will be for $55,000 with an APR of 7% (weighted average and rounded up to the nearest one-eighth percent).
With the 10-year Standard Repayment Plan, your monthly payment would be $639 over 10 years. But since you can only afford $550, you opt for the extended consolidation repayment plan over 25 years, which puts your monthly payment at $389. Now you can make the minimum monthly payment, plus $161 extra.
With the new interest rate and extra dollars, you’ll pay off the loan in approximately 151 months (roughly twelve-and-a-half years) with $27,785 in interest.
Use this student loan consolidation hack instead
Although people tend to use Direct Loan Consolidation to merge all of their loans together into one, you don’t actually have to do it that way. In fact, you can consolidate just one loan by itself. And you can save money by doing so.
Let’s take the same loan information above, but consolidate the loans separately.
The first loan would have a monthly payment of $123 over 25 years and would retain its 5.5% APR. The second loan would have a monthly payment of $264 over 25 years, and the APR would stay at 7.75%.
Now, here’s where it gets fun. Between the two newly consolidated loans, you have a monthly payment of $387. But now, you can be a little more strategic about how you pay down your two loans.
The best way to do this is to use the debt avalanche method. Similar to the debt snowball method, you aggressively pay down your loan with the highest interest rate first, while paying the minimum payment on all your other loans. Then, once the first loan is paid off, you funnel all the money into the other loans to pay them down more quickly.
In this scenario, you would put the extra $163 toward the 7.75% APR loan for a total of $427 per month. At the same time, you’ll continue paying $123 a month on the 5.5% APR loan. Once the 7.75% APR loan is fully paid off, you’ll put the full $550 per month toward the 5.5% APR loan. With this strategy, you’d pay off the loans in 146 months and pay $25,635 in total interest.
By using this method, you’ll pay off your student debt five months early and save $2,150 in interest payments.
Should you consolidate your student loans?
If you already have low interest rates on your federal student loans but can’t afford the payments, consolidating them can qualify you for an extended repayment period, lowering your monthly payments.
“The biggest danger is consolidating PLUS loans into a consolidation loan with other loan types,” says Farrington. “PLUS loans don’t offer the same repayment plans as other Direct Loans, and when you consolidate a PLUS loan with the other loans, you lose access to income-driven repayment programs and the forgiveness plans that come with that.”
Consolidating your loans separately, rather than together, can help with that problem. Doing separate consolidations can make for more work, as you still have more than one payment to remember. But coupled with the debt avalanche repayment method, you can save thousands of dollars in interest over the life of the loan.
Consolidation isn’t the only way to save money, though. If you have high interest rates and can qualify for lower rates through refinancing, then you should compare the best student loan refinancing lenders to get the best rate.
Ben Luthi is a personal finance writer and a credit cards expert who loves helping consumers and business owners make better financial decisions. His work has been featured in Time, MarketWatch, Yahoo! Finance, U.S. News & World Report, CNBC, Success Magazine, USA Today, The Huffington Post and many more.