Millions of Americans are dealing with debt – in the form of credit cards, personal loans, student loans, and more. Although it is often a means to an end, managing various types of debt can be overwhelming for even the savviest consumer.
For some borrowers, consolidating debts can be an appealing option. Debt consolidation can take many forms, but in most cases, it means taking out a single, lump-sum loan which is used to pay off several other debts. The hope of consolidation is that it offers some respite from paying multiple creditors each month, and for borrowers with strong credit and income, the potential to lower the total interest rate charged on debt.
One of the considerations for many borrowers with student loan debt is consolidating multiple types of loans or credit cards. This can be done in several ways, but it isn’t always the most cost-effective strategy for managing student loan debt.
There are several pros and cons to consider when consolidating student loans with other types of debt, along with various methods for doing so if it makes sense. Here’s what you need to know.
The Pros and Cons of Consolidating
When it comes to consolidating student loan debt with other forms of debt, there are some advantages. First, combining multiple debts gives borrowers an opportunity to streamline debt payments, instead of keeping up with several obligations each month.
Additionally, consolidating student loan debt may also reduce the interest rate, which can lower your monthly payment. Some borrowers might also prefer to extend repayment with a new consolidation loan, giving more time to repay balances from multiple sources.
There are also significant drawbacks to this strategy. Federal student loans that are consolidated into another form of a loan and combined with other debts lose valuable consumer protections. The ability to select an income-based repayment plan, options for deferment and forbearance, and potential student loan forgiveness after a period of time all go away when consolidating student loans with other debt forms. These choices give borrowers more flexibility during times of financial hardship and can help lower their chance of default.
Also, borrowers who consolidate student loans into another form of debt will likely have to meet stricter credit requirements to qualify. This might not be an option for borrowers who are just getting started in their career or who have little to no credit history.
Types of Consolidation Loans
Borrowers with either private or federal student loans may have an option to consolidate their debt with another type of loan. Each of the choices below has different requirements for eligibility, as well as advantages and risks that should be weighed before making a final decision. Let’s review the most common options for consolidating student loan debt.
Home Equity Loan
A home equity loan can be available to homeowners who have equity in their primary residence. Equity is simply the difference between the market value of the home and the balance owed on the mortgage loan. When equity is present, banks and credit unions offer home equity loans to qualified borrowers, based on an appraisal of the home’s value, the borrower’s’ credit history and score, and his or her income level.
The benefit of using a home equity loan for refinancing student loan debt is the potential to drastically lower the interest rate. Most home equity loans have single-digit interest rates that can be a few percentage points lower than student loans, and lenders typically offer fixed rates. The repayment term of a home equity loan can be several years, potentially making the monthly payments more affordable.
However, home equity loans come with closing costs that may not make this option worth it. Also, homeowners who use home equity to consolidate student loans are tying their biggest asset to a lender. If payments are missed, the lender has the right to seize the home, which can be devastating on many levels. So it is essential to consider these ramifications before consolidating student loan debt with home equity.
Balance Transfer Credit Card
Another option for consolidating student loan debt is through a balance transfer on a credit card. Balance transfers often provide minimal or zero interest for a set period, typically 12 to 18 months, which can reduce the total cost of borrowing.
However, balance transfers have many drawbacks. First, balance transfers typically charge fees ranging from 1 percent to 5 percent of the amount transferred. Also, borrowers only reap the benefit of consolidating debt through a balance transfer when the total amount can be paid off in the low- or no-interest period. Most student loan balances are high enough that this isn’t a feasible option.
Balance transfer credit cards are also only available to borrowers with strong credit. And even then, the limit of a new card might not be high enough to make consolidation a good option.
Personal loans are also an option for consolidation of student loan debt. And personal loans are often unsecured, meaning they do not require collateral like a home or other assets to get approval. For this reason, personal loans may have slightly higher interest rates than federal or private student loans.
It is also necessary for borrowers to recognize that personal loans have shorter repayment terms, ranging from three to seven years in most cases, which could create more of a burden in repayment than standard student loans. Personal loans may also have fees for origination, ranging from 1 percent to 5 percent, which can add to the total cost of borrowing.
Debt Consolidation Loan
A debt consolidation loan is similar to a personal loan in that it has a fixed interest rate and steady payments due each month. However, a debt consolidation loan differs in that it can only be used for consolidating debts. This means that student loan borrowers may use this option to consolidate their balances, but it comes with the same drawbacks as a personal loan.
Refinancing Your Student Loans
Consolidating all of your debt, including student loans, into a new form of debt may be beneficial if you can drastically reduce the interest rate, extend the repayment term, or expedite repayment with a low- or no-interest loan. However, often student loan borrowers can benefit from keeping student loans and other debts separate.
Another way to do this without combining your student loans with other debts is through private student loan refinancing. This strategy involves taking out a single loan from a private lender to pay off one or more federal or private student loans, potentially lowering the interest rate or offering more amenable repayment terms.
Private student loan lenders, however, have certain credit requirements that borrowers must meet in order to qualify. Borrowers need to know that refinancing federal student loans with a private loan takes away the inherent benefits of income-based repayment plans and potential loan forgiveness in the future.