Borrowers can cash in on student loan consolidation

Physicians have plenty to celebrate as they finish their extensive medical training, but the looming onset of school loan repayments can cast a shadow on the party.

The typical American physician graduates from medical school with more than $109,000 of debt, according to the Assn. of American Medical Colleges. And though most of that debt is likely in the form of low-interest student loans, if it isn't handled properly, it can cause financial woes for years.

But experts say there may be some cause for cheer. With interest rates at historic lows, students can take advantage of loan consolidation to lock in rates that save money, or at least make the monthly loan repayments less burdensome. Though it is not right for everyone, experts say loan consolidation is worthy of consideration by borrowers searching for debt relief.

"It's worth it to take a look. Every person has got to do what they feel is right. But it [can] really be a win-win for the borrower," said Paula Craw, director of student financial services for the AAMC.

The process of loan consolidation is fairly simple: It involves refinancing multiple loans with one new loan. The goal is to make monthly payments smaller and more manageable.

"It's a reorganization of your loans, lumping them all together so it's easier to manage. You're only dealing with one lending institution, and in most cases, at least now, you'll probably get lower interest rates and lower monthly payments," said Brian O'Connell, a former Wall Street bond trader who is now an author and consultant in Doylestown, Pa. "The simplicity is hard to argue with."

However, he said, loan consolidation also extends the life of the loan, which may be a disadvantage to borrowers who are eager to pay off their debts. "It's like extending out your mortgage," O'Connell said.

Craw said consolidation can stretch out loan repayments for up to 30 years. "Of course, if they pay back over a longer period of time, they're going to pay more in interest or total costs," she said. "But the biggest advantage now is that they can lock in a rate."

Consolidation allows borrowers to lock in one fixed interest rate for the life of the loan, while many unconsolidated loans have variable rates that are subject to the vagaries of the market. Craw said the interest rate on consolidated loans is calculated by using the weighted average of all the loans that are being consolidated.

That means people with Stafford loans, the most common federal loan, or other loans with variable rates can benefit from consolidation by locking in the rates when they drop, said Pat Scherschel, an Indianapolis-based executive with the national student loan provider Sallie Mae. She said rates on Stafford loans could soar to 8.25% if the market turned. Right now, the rates are as low as 2.875%.

Rates can make a big difference in the size of monthly payments. A recent report by the AAMC said physicians at the end of residency with $150,000 in debt would pay $1,761 per month if their unconsolidated loans had current interest rates of about 2.82%. If the rates were 8.25%, monthly payments would be $2,436 without consolidation. Monthly payments for consolidated loans would be $676 or $1,349, respectively.

But some borrowers might want to avoid consolidation because it prevents them from taking advantage of future rate decreases. Loans cannot be reconsolidated. "It's not like a home mortgage where you could refinance several times to get a better rate. In this program, once you fix the rates, you're done," said Craw.

Scherschel said another potential disadvantage is that some people will lose borrower benefits, such as rewards for timely payments, by consolidating their loans.

She also warned against spouses consolidating their loans together because those loans could remain linked even in the event of a divorce.

All of this depends on the type of loans that are being consolidated. Private loans can be consolidated among themselves, but Scherschel said they have different characteristics that can outweigh the benefits of consolidation. And federal Perkins loans could lose their government subsidy through consolidation, she said.

Federal loans can be consolidated by private lenders following rules set by the government. But not all lenders are eligible to consolidate all loans. And borrowers whose loans are all owned by the same holder must consolidate through that entity under the so-called single-holder rule, said Craw. Experts recommend that borrowers contact their original lenders or the U.S. Dept. of Education to find out where they can get their loans consolidated.

The AMA has lobbied Congress to retain and strengthen federal loan consolidation, which may be considered as part of the reauthorization of the Higher Education Act.

In a statement to lawmakers last summer, the AMA said loan consolidation played a "critical role in enabling new physicians to manage the enormous debt they incur during their medical education."

Among key points, the AMA has advocated retaining a fixed rate on consolidated loans and eliminating the single-holder rule.