Student debt: Is one bill better?

Bundling your loans can free up cash and simplify your finances. But it's not always the right move.

By Dennis Murray
Senior Editor

For Joe, a newly minted internist, it's time to start paying the piper. He has half a dozen medical school loans in various amounts from different lenders; together they total $100,000. That's typical for young physicians these days, according to the Association of American Medical Colleges.

Joe's medical school obligations total $1,500 a month, which he'll pay over 10 years. If he consolidates those debts and stretches his payments over 30 years, he'd bring his payments down to around $1,000 a month. That's going to increase the total interest he pays by more than $155,000, but at this stage in his life—he has one child already and another on the way—an extra $500 a month would take some of the pressure off him and his wife.

Is a consolidation loan right for Joe—or for you if your situation is like Joe's?

"A consolidation loan makes it easier to budget because now there's a single student-loan debt to manage each month, instead of several," says Gayle Buff, a financial adviser in Newton, MA. You may also be able to further shrink the size of your payments, based on your adjusted gross income and total debt, she adds.

But a consolidation loan does have its drawbacks—not the least of which is the fact that you may be nearly doubling the total payment for your education. To see if one is right for you, review the following questions and answers.

Does a consolidation loan provide any tax benefits?No more than you'd receive on a number of individual loans. The entire loan picture got better last year, though, when Congress increased the income limits for deducting interest on student loans. Under the old rule, deductions for interest on student loans, including consolidation loans, were reduced for a married couple filing jointly once their adjusted gross income reached $60,000; at $75,000, deductions phased out completely. Starting with the 2002 return, the new range is $100,000 to $130,000 for joint filers ($50,000 to $65,000 for singles). You can't, however, take a student-loan interest deduction if you're married and file separate tax returns.

"The new limits may allow some married physicians to qualify for the deduction, even if they previously didn't because their AGI was too high," says Mary McGrath, a financial planner with Cozad Asset Management, in Champaign, IL.

One part of the revised regulations may make a consolidation loan more appealing: Interest deductions are no longer limited to the first 60 months of a loan. So it won't matter how long you stretch your payment schedule. Whether you choose to consolidate your loans or not, if you stopped deducting interest on a particular loan because of the 60-month limit, you can resume your write-offs beginning in 2002, assuming your income doesn't exceed the new limit.

When doesn't it make sense to consolidate? Consolidating won't save you a lot if you'll retire your loans within a year or two. Moreover, if you have mostly variable interest rates, don't rush to combine your loans; the total interest on a fixed-rate consolidation loan may be greater over the same term. Currently, the rate is the lesser of 8.25 percent or the weighted average of the interest rates of the loans being consolidated, rounded up to the nearest eighth of a percentage point.

Which types of loans are eligible? All of the major federal ones, including:

• Subsidized and unsubsidized Direct Loans
• Subsidized and unsubsidized Stafford Loans (formerly Guaranteed Student Loans)
• Direct PLUS Loans and Federal PLUS Loans
• Federal Insured Student Loans
• Federal Supplemental Loans for Students
• Auxiliary Loans to Assist Students
• Perkins Loans (formerly National Direct Student Loans)
• Health Education Assistance Loans (HEAL)
• Health Professions Student Loan
• Nursing Student Loans
• Loans for Disadvantaged Students

What if I have private loans, too? By law, private loans and federal ones can't be combined. So you'll need two separate consolidation loans—that is, if your private lender offers consolidation, which many don't. "When you call, ask to speak with a loan officer in the consolidation department," says Brian Dilley, a financial counselor with Chicago-based Mediqus Asset Advisers. "Otherwise, you're likely to get conflicting or inaccurate information."

Can I include a loan that I've defaulted on? It depends. The guidelines for eligibility are complicated, and vary by lender. But even if you pay off such a debt with a consolidation loan, the fact that you'd defaulted will remain on your credit report for seven years, which could affect your ability to borrow. A smarter move would be to "rehabilitate" the loan first—make full, on-time payments for 12 consecutive months—then consolidate it. That way, the default notation will be removed from your credit report.

Where can I find a lender to consolidate my loans, and must I pay an application fee? There are no fees involved. However, if all of your loans are FFELP (Federal Family Education Loan Program) Staffords owned or held by a single lender, federal law requires you to first contact that lender about consolidation.

You can go elsewhere only if the lender doesn't offer consolidation, or doesn't offer it with an "income-sensitive" repayment option. In either case, you could then apply with Sallie Mae ( www.salliemae.com/apply/borrowing/smartloan.html), which also processes and services consolidation loans for Nellie Mae, or with Direct Consolidation Loans (www.loanconsolidation.ed.gov) if you have Direct or Direct PLUS Loans. If you have loans from private lenders, check with Citibank (www.studentloan.com) and Collegiate Funding Services (www.cfsloans.com ), which contracts with private lenders to service its loans.

Even if all of your student loans are from the same lender and consolidation won't reduce your interest payments, you might still benefit from bundling your loans. Ask your loan officer if you have access to "administrative consolidation," which allows you to make a single payment that the lender then apportions to your different loans. This is sometimes referred to as "combined billing."

Do interest rates vary much? Rates for federal loans change once a year, on July 1, and are based in part on the most recent rates for a 91-day Treasury bill. From 2000 to 2001, the T-bill rate spread was 2.2 percentage points.

"I'm advising my doctors with medical school debt to look very closely at consolidation now," says Brian Dilley. "Because the consolidation rate for the next year will be based on the T-bill rate offered at the end of May, we'll have a small window of opportunity to lock in the current rate if the new rate appears that it will be higher. If rates look like they will stay the same, or drop, we'll wait until after July 1 to apply for the loan."

How can I determine what type of payment plan is best for me? Ask the lender's loan officer to run the numbers for you. Or if you're applying for a Direct Consolidation Loan, you can use the online calculator at www.loanconsolidation.ed.gov. Click on "Borrower Services." You'll find the calculator under "Additional Resources."

Some lenders may offer slightly lower rates (around 0.25 percent less) if you agree to repay your consolidated loan through an automatic draft.

Should my spouse and I consolidate our loans into a single package? That's usually not wise, for a couple of reasons. First, if you die or become permanently disabled, your portion of the debt won't be discharged and your spouse will be obligated to pay the balance. If you have individual consolidation loans, a deceased or disabled spouse's balance is forgiven. Moreover, a consolidation loan can't be dismantled if you get divorced, and you'll both be responsible for paying down the entire loan.

How will my payments be applied? Can I pay off the loan early without penalty? Regular payments are applied first to any late charges, next to unpaid interest, then to principal. You can pay off a federal loan early without penalty. The rules vary with private loans, but most large banks won't dock you.

Can I get a deferment on a consolidated loan? In general, yes, if you become disabled temporarily; you haven't been able to find a full-time job or can prove economic hardship; you're enrolled full time in a graduate fellowship program; or you're a reservist who's been called to active duty. However, be aware that interest will continue to accrue on the unsubsidized portion of your consolidation loan during grace or deferment periods. For more on the impact of consolidation on these benefits, read the primer on the Association of American Medical Colleges' Web site, www.aamc.org/debtmanagement .

 

Dennis Murray. Student debt: Is one bill better?. Medical Economics 2002;10:39.