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Why Should You Consider Loan Consolidation
By: Maria Cutikk
Debt consolidation entails taking out one loan to pay off many others. This is
often done to secure a lower interest rate, secure a fixed interest rate or for
the convenience of servicing only one loan.
Debt consolidation can simply be from a number of unsecured loans into another
unsecured loan, but more often it involves a secured loan against an asset that
serves as collateral, which is most commonly a house (in this case a mortgage is
secured against the house.) The collateralization of the loan allows a lower
interest rate than without it, because by collateralizing, the asset owner
agrees to allow the forced sale (foreclosure) of the asset in order to pay back
the loan. The risk to the lender is reduced so the interest rate offered is
lower.
Because of the theoretical advantage that debt consolidation offers a consumer
that has high interest debt balances, companies can take advantage of that
benefit of refinancing to charge very high fees in the debt consolidation loan.
Sometimes these fees are near the state maximum for mortgage fees. In addition,
some unscrupulous companies will knowingly wait until a client has backed
themselves into a corner and must refinance in order to consolidate and pay off
bills that they are behind on the payments. If the client does not refinance
they may lose their house, so they are willing to pay any allowable fee to
complete the debt consolidation. In some cases the situation is that the client
does not have enough time to shop for another lender with lower fees and may not
even be fully aware of them. This practice is known as predatory lending.
Certainly many, if not most, debt consolidation transactions do not involve
predatory lending.
What is a Federal Student Consolidation Loan?
A Federal Consolidation Loan is a loan that you can use to pay off all or a
portion of your original eligible federal student loans. You combine
(consolidate) your existing federal student loan debt into one new loan.
What are the terms of a Federal Consolidation Loan?
• The interest rate on a Federal Consolidation Loan is fixed, meaning it will
not change over the life of the loan, even if the interest rates on other
federal loans go up (or down).
• The interest rate is calculated from the weighted average of the interest
rates of your
existing loans, rounded up to the nearest 0.125%, with a cap of 8.25%.
• There are no fees to apply for or receive a Federal Consolidation Loan.
• The repayment term is up to 30 years, depending on the total amount of your
student loan debt, and there is no pre-payment penalty.
Why should you consider consolidation?
With a Federal Consolidation Loan, you can benefit from:
• Lower monthly payments
• Fixed interest rates
• Only one payment for your federal loans each month
• New or renewed deferments
Because you are allowed up to 30 years to repay your loan, your monthly payment
can be significantly lower with a consolidation loan, although you may pay more
in total interest over the life of your loan.
When should you consolidate?
Only loans that are in grace, deferment, forbearance, or repayment can be
consolidated into a Federal Consolidation Loan. Loans that have an in-school
status cannot be consolidated.
There are no deadlines. However, Federal Stafford Loans that are in the grace
period (or in deferment) have the lower rate compared to loans in repayment (or
forbearance). Because the current interest rate is used in the calculation to
determine the weighted, fixed interest rate of your consolidation loan, you will
save money over the long run if you consolidate while in your grace period or
while in deferment. (If you choose to consolidate while in your grace period,
keep in mind that your grace period will be cancelled when the consolidation
loan is issued and you will begin repayment.)
Student loan consolidation
In the United States, federal student loans are consolidated somewhat
differently, as federal student loans are guaranteed by the U.S. government. In
a federal student loan consolidation, existing loans are purchased and closed by
a loan consolidation company or by the Department of Education (depending on
what type of federal student loan the borrower holds). Interest rates for the
consolidation are based on that year's student loan rate, which is in turn based
on the 91-day Treasury bill rate at the last auction in May of each calendar
year.
Student loan rates can fluctuate from the current low of 4.70% to a maximum of
8.25% for federal Stafford loans, 9% for PLUS loans. The current consolidation
program allows students to consolidate once with a private lender, and
reconsolidate again only with the Department of Education. Once the student has
consolidated their loans, the loans are set to a fixed rate based on the year
they consolidated; reconsolidating does not change that rate.
Federal student loan consolidation is often referred to as refinancing, which is
incorrect because the loan rates are not changed, merely locked in. Unlike
private secton debt consolidation, student loan consolidation does not incur any
fees for the borrower; private companies make money on student loan
consolidation by reaping subsidies from the federal government.
Student loan consolidation can be beneficial to students' credit rating, but
it's important to note that not all federal student loan consolidation companies
report their loans to all credit bureaus; SLM Corporation (formerly Sallie Mae)
does not report to Experian or Transunion, which means that students will have
differing credit scores at Equifax, Transunion, and Experian.
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