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One Reason Not to Consolidate Your Student Loans

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I recently worked with a young client who graduated law school with a significant amount of student loans. His school highly recommended that he consolidate his loans, which he did. However, after reviewing his financial situation, it seemed that NOT consolidating would have made more sense for him.

I was curious to see what information was available when I searched for articles that discussed the pros and cons of student loan consolidation. There were several helpful sites that I suggest recent graduates read and research prior to making a decision about consolidation. Below are a few links to get you started in the process.

http://www.asa.org/repay/options/consolidate/default.aspx

http://studentaid.ed.gov/repay-loans/consolidation

http://loanconsolidation.ed.gov/borrower/bconsol.html

When you consolidate student loans, you combine one or more federal student loans into a new loan with one payment per month rather than multiple payments to various lenders. Other than the convenience of having to make only one payment, most of the benefits of consolidation are for borrowers who have difficulty making the standard monthly payments. For example, consolidated loans have more flexible repayment options that may lower the monthly payment and even allow borrowers who qualify to take advantage of Public Service Loan Forgiveness.

However, in these articles there was no mention of the one reason that consolidation was not beneficial for my client. And that is if you plan on paying off your loans early, it may be better not to consolidate multiple loans with different interest rates. When loans are consolidated, you end up with a weighted average of the various interest rates as the new interest rate (unfortunately student loans cannot be refinanced at a lower rate). With separate loans you can target the one with the highest interest, then the next highest interest, and so on. This is a strategy much like what one would use to pay off credit card debt. By targeting the higher interest rate loans, rather than one consolidated loan with an average interest rate, you can pay off the loans slightly faster and pay less interest over the repayment period. Of course, not everyone is in a position to make more than the minimum payments on their student loans. However, if you are able to make extra payments with your income and cash flow, it may make sense over the long-term especially if you are paying interest rates in the 7-8% range.