Student Loan Consolidation Rate
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Student loan consolidation works in principle the same way that a mortgage refinance works. You are simply obtaining a loan with hopefully better terms in order to pay off another loan or loans where the terms are relatively not as good.
Our goal here is to clear up some misunderstanding that seems to be floating around the Internet about student loan consolidation. This misunderstanding centers around the interest rate for the consolidated loan. Many student loan brokers and some lenders want you to believe that the total interest paid for the consolidated student loan is less then what you would pay compared to the accumulated interest paid for several student loans. Here we will explain that this is not always the case, and that the timing of the consolidation is the most important factor if you desire to lock in a lower interest rate for the consolidated loan.
If you consolidate your student loans and you extend the term length, while reducing your monthly payments, you can actually end up paying more in total interest during the life of the loan. We will expand on this further in our discussion.
The potential and most important advantage to student loan consolidation is to lock in a lower interest rate for the consolidated loan. Lets first examine how the lender determines the interest rate for the consolidated loan.
For student loan consolidation, the interest rate for the consolidated loan is the weighted mean interest rate for the total student loans, and rounded up to the nearest 1/8 of a percent. Lets look at an example of this. Lets say you have two loans that you want to consolidate. One loan is $5,000 at 5% and the other loan is $10,000 at 6.8%. The formula for the weighted mean here would be as follows: ( symbol * means multiply)
| $5,000 * 5.0% + $10,000 * 6.8% | |
| ——————————————————— | = 6.2% |
| $5,000 + $10,000 |
The weighted mean here is 6.2%. To round up to the nearest 1/8 percent gives you 6.25%. The interest rate for the consolidated loan will always be between the highest and the lowest interest rate for the various loans that you have, and can not be greater then 8.25%.
In the example given above on a 10 year term, $10,000 at 6.8% has a monthly payment of $115.08 and total interest paid of $3,809.66, $5,000 at 5.0% has a monthly payment of $53.03 and total interest paid of $1,364.03. If you add these, you obtain a total monthly payment of $168.11 and a total interest paid of $5,173.69. Using the weighted average, $15,000 at 6.2% has a monthly payment of $168.04 and a total interest paid of $5,165.01. As you can see the total interest paid is about the same.
When you consolidate, the interest rate is rounded up to the nearest 1/8th of a point, so $15,000 at 6.25% has monthly payments of $168.42 and total interest of $5,210.42, which results in a slight increase. So in this particular case you can see that there is no savings at all in terms of interest paid out for the life of the loan.
If you set up a consolidated loan with a longer term, this means that you pay interest for a longer period of time and inevitably will end up paying more interest on the consolidated loan. So what is the advantage to student loan consolidation? The key is the timing of the consolidation.
Interest rates on new federal student loans first disbursed on or after July 1, 2006 have a fixed interest rate of 6.8%. Federal student loans disbursed before July 1, 2006 will remain variable interest rate loans. The interest rate for these loans will re-adjust every July 1 based on the results of the 91-day Treasury Bill Auctions. So if you took a loan out before July 1, 2006 and you consolidated your loans before this date, this was a wise choice because you locked in a lower interest rate. You only want to consolidate if you have a variable interest rate loan because consolidated loans have a fixed interest rate, and it would be advantageous to lock in a lower interest rate through consolidation before a rate hike takes place. If the interest rate is expected to drop, you should wait until this time and then consolidate. So timing is everything.
There are other less important advantages to student loan consolidation, such as making it more convenient to pay by having one bill, and reducing the amount you pay per month by extending the length of the term for the new loan. But remember, if you extend the term length of the loan, you will end up paying more total interest. The whole objective to student loan consolidation is to reduce the cost in terms of your repayment, not to increase your cost. Since timing is everything when it comes to student loan consolidation, it is important that you keep a prudent watch on the interest rate, especially as July 1 approaches.
When consolidating, remember that just about any lender can do the consolidation, and if you are not satisfied with the terms, you can use the Federal Direct Consolidation Loan Program. Also, do not use a loan broker, simply because they will charge a fee. A student loan consolidation can be completed by talking with your local lender. Using a student loan broker defeats the purpose of reducing your cost for repayment of your student loans. By simply going to websites like this one and others can result in you gaining enough knowledge in order to make the right decision for your student loan situation.
Student Loan Consolidation Rate - Conclusion
The student loan consolidation rate in terms of interest is probably the most important factor when deciding if student loan consolidation is right for you. Setting up a consolidation does not automatically result in a savings of interest paid out in terms of repayment. The timing of the consolidation is the most important factor to consider. If you decide to consolidate, make sure you completely understand the terms of the consolidated loan, and if you are not satisfied with the terms, simply do not consolidate or look else where, such as the Federal Direct Consolidation Loan Program.
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