In this edition of the student loan plan, we take a look at Mallory’s federal student loan dilemma.  She has a total of eight student loans, some subsidized, some not, with a range of interest rates.  If you want tips for dealing with your student loans, contact us.

Mallory Writes:

Let me start by admitting that I am completely ignorant to all things student loan-related. I have been trying really hard to understand through my own online research, but still have major confusion.

I currently have eight loans through Navient (formerly Sallie Mae) – five subsidized, three unsubsidized – all with interest rates ranging from 4.5-6.5%. I feel like I’m not even scratching the surface on my principle, and only paying toward my interest. I am wondering if consolidation is right for me? I am not necessarily looking to lower my monthly payment (although, that would be wonderful!), I am more concerned with actually paying toward my principle and not just toward the interest.

I have a good paying job and decent credit – even have a cosigner if necessary. But I’m just not sure if that’s the correct route to take. I need advice and facts related to my specific scenario. A lot of what I read online covers all sorts of factors that I don’t think apply to my situation, which can be very confusing.

Any help is greatly appreciated!

The Plan

It is really easy for this decision to quickly become very complicated.  The decision to consolidate federal student loans with a private lender is difficult because there is no undo.  Once you pay off your federal student loans, there is no way to get back the perks that came with those loans.  We can get into salary projections, personal risk aversion, and some deep financial analysis in making this decision.  From the sound of Mallory’s email, it appears going back to the basics might be the best route for her.  At the very least it is a good starting point.

We can boil all of the factors that go into making this decision into two questions.  Answer these questions carefully, and you have your decision.

Can I Save Money by Going with a Private Lender?

The answer here really depends upon your credit score and income.  If these numbers are good, odds are pretty good that you will be able to get lower interest rates on the private market.

Private rates are normally lower than the federal rates because borrowers are judged based upon their ability to pay.  The less of a credit risk you are, the less you will have to pay.  The federal government treats borrowers the same, regardless of their credit score or income.  All freshman starting school this fall get the same interest rate, the only question is whether or not it will be subsidized.

Going back to Mallory’s original question, the subsidized loans are worth examining a little closer.  If the interest is being subsidized to this day, it is effectively a 0% interest loan… meaning she won’t do better on the private market.

The interest rates that Mallory currently has appear to be good but not great.  Many borrowers are stuck with rates much worse than Mallory’s, but it is definitely possible to improve Mallory’s current rates.  The key to getting the best rate is to shop around.  We try to track all of the national lenders in one place, so that you can get a good idea of what is out there.

A final tip would be to keep in mind that there is no requirement that you consolidate all of your debt.  If Mallory can find a 5.0% interest rate out there, she can refinance the higher interest loans and leave the lower interest rate loans untouched.

Am I willing to give up the federal perks?

Answering this question can get complicated pretty quickly.  To simplify it we will look at the two most common federal perks that borrowers may really want to keep.

The first one is the student loan forgiveness programs.  These programs usually take one of two forms:  Forgiveness after 10 years of payment while working in a public service job, and forgiveness after 20 to 25 years of repayment on an income driven plan.  We won’t delve into the details and nuances of these programs today, but if you think you stand to have a lot of debt forgiven, you probably don’t want to consolidate your debt with a private lender.

The second perk is the income driven repayment plans, such as IBR or Pay As You Earn.  What makes these plans special, in addition to the forgiveness option, is the flexibility they afford.  Suppose Mallory worried about maintaining her income level in the long-term.  The security of income driven repayment means that if her salary drops, the monthly payments on her student loans drop.  This means that during tough months or years, student loans are far less likely to destroy Mallory’s credit score.

Making the decision

The trick in making this decision is placing an appropriate value on the federal perks.  If private consolidation is only going to save you $5 per month in interest, it is probably best just to pay a little extra and stay with Uncle Sam.  Treat the extra cost as unemployment/underemployment insurance.  For a few bucks a month, it is money well spent.  If you are spending hundreds extra each month on the off chance you lose your job, private consolidation might be worth your effort.

Bottom Line: shop around, figure out how much you can save, and weigh the risk vs. the reward.