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Consolidating loans...good or bad?

Old 04-27-05, 01:25 AM
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Consolidating loans...good or bad?

Hey all, I need someone to explain consolidating to me. I have a vague idea of what it is, but when it comes down to it, I need details to help me out.

I've been getting all these letters recently, like from Sallie Mae, telling me to consolidate my loans and what not, saying that my interest rate will go up soon, blah blah blah, and that consolidating them now could lower my monthly payments.

My understanding is that if I do consolidate, my monthly payments will go down, however in the long run, i'm still paying more interest and it'll take me longer to pay off. Am I right?


edit: I have absolutely no problem paying off my current payments.

Last edited by mytzplyx; 04-27-05 at 01:30 AM.
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Old 04-27-05, 01:53 AM
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Consolidating means two things:

1) You combine all your separate payments into one.
2) You change your payment plan (i.e. from 10 years to 20, etc.).

Now, the first thing by itself saves you money, both month-to-month and overall. This is because you're just paying interest once--and it's the lowest it can be--rather than multiple times at different rates.

However, when most people consolidate, they also change their repayment plan from the standard length of time to some sort of extended plan. This makes your overall monthly payment lower, but because you're accruing interest for a lot longer, you end up paying more in the end. I personally recommend doing whatever is easy and affordable for you now; there's no sense in struggling to pay that bill just to save a small amount of total interest in 10+ years.

EDIT: I forgot to mention--if you consolidate through some 3rd party company like Sally Mae, be sure to read all the fine print. When you change lenders, you may very well lose some of your prior benefits such as the ability to defer your payments for x months, etc. Plus the penalty for a late payment might be harsher, etc., so you really have to stay on top of it if you don't want to get screwed.
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Old 04-27-05, 07:20 AM
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Consolidating, and really all of consumer finance, boils down to something very simple, and very short: Do whatever has you pay the least amount of money.

The "trifecta" of doing something and having it make sense is if you pay a lower interest rate, you pay off your loan sooner, and your payments are less. If that is available, pounce on it immediately.

If you ever "stretch" out your term -- that is, go from 5 years to 7 years, or 20 years to 25 years, you will pay more money over time -- in theory. In reality, if these lower payments prevent you from having to accumulate more debt, or allow you to invest more money in something that will outperform the debt* then you are on track.

If you do stretch out your term, I'm sure you don't have to make the minimum payments. Say you are 8 years into a mortgage but your spouse is going back to school for a couple of years. Maybe stretching out the term on your mortgage to save $200/m is fine, because there will be a drop in income for the next three years. Just make sure after the 3 years, you make payments so you are on track to have the home paid off at your goal.**

Basically, figure out your costs from now until your current debt is paid off. Then figure out those costs under the new plan. If one costs more, decide for yourself if the advantages outweigh that cost.***

If the advantage is not that much (say, save $400 over six years), and it's a lot of hassle, then don't bother with it.

Just a final note for those with credit card debt undergoing Consumer Credit Counseling. It will hurt your credit, it does not matter how many times they tell you that it will not, it will.

___________________________________________________

* Example #1: You have a student loan that you have converted from a 5-year loan to a 10-year loan, saving you $100/m. Say that loan is at 5.5%. Now, if you invest those $100/m every month in a mutual fund that gets you 10% over the next 10 years, you've done well. That $100/m cost you 5.5%, but you earned 10% on it. You can get more complex figuring out taxes, etc, but this is a good start.

** Example #2: Your payments right now are $1500/m. If you go back to a 30-yr mortgage, they will drop by $200/m, but you've haven't "lost" the eight years you've paid in. Figure out what the term is if with the new loan, you send in $200/m per month. If it can pay off your mortgage in 22 years or less, you are on the right track.

*** Example #3. You have five years left on a $10,000 loan at 7%. Your payments are $198. You've been given the option to change that to a ten-year loan at 7.25%. The upside? Your payments go down to $117.

Well, $198 x 5 x 12 = $11,880. That's the five-year loan.
$117 x 10 x 12 = $14,040. That's the ten-year loan.

As you can see, the ten-year loan has more paid over time. $14,040 - $11,880 = $2,160 to be exact.

So if by taking the new ten-year loan, you are paying an extra $2,160 over the next five years. That works out to abouit $432 extra per year, and $36 extra per month, for the next five years.

However, you are saving $81/m because your minimum payments are lower. $198 - 117 = $81. But after five years, you still have the $117/m payment.

So, is it worth it? That's for you to decide.
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Old 04-27-05, 08:29 AM
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Excellent advice already given. I'll just add that if part of your consolidation includes multiple credit cards, then I'd recommend eliminating some cards when consolidating. Get down to 1 or 2 cards. (assuming similar credit lines)

I've seen far too many people consolidate their debts only to rack up more because they had cards with no balances.
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Old 04-27-05, 09:19 PM
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My loans are all student loans. I owed about $22k 2 years ago, but now I owe about $10k combined, through sallie mae and through citibank student loans.

Thanks for the advice. I'm gonna see what they're gonna give me.
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Old 04-27-05, 09:24 PM
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You should do this before July 1st, as interest rates on your federal loans are at an all-time low right now - 2.77%. It's supposed to rise around 1.5-2% on July 1st, so I'm going to consolidate right after graduation (mid-May). We had a talk by the AAMC's financial aid department on this, and this year it just makes sense to consolidate. If all your federal loans are at 2.77%, then I believe that your locked-in rate (after rounding up to the nearest eighth of a percent) would be 2.875%.
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