Mull the Benefits of Loan Consolidation

Physician's Money Digest, February15 2004, Volume 11, Issue 3

Should you consolidate your student loans? According to the American Association of Medical Colleges, the average medical student graduates with approximately $109,000 in education debt, which is an overwhelming amount for most young physicians. In many cases, the issue becomes whether to consolidate the student loans into one loan.

Let's address a few of the major issues when dealing with loan consolidation to see if it's appropriate for you. It's important to remember that once you've consolidated, there's no going back, so it's crucial to make the appropriate decision.

• What happens when you consolidate loans? A consolidating lender issues a new loan, which combines all of your individual loans into one. When the consolidation occurs, a new repayment schedule is issued. This is calculated by the size of your new consolidation loan, the new interest rate, and the repayment plan chosen. By consolidating your loans, you have one loan with one payment to one lender, instead of multiple loans with multiple payments to multiple lenders.

• How is the new interest rate calculated? The new rate on the consolidated loan will be fixed, as opposed to your current rate that fluctuates from year to year. The new fixed rate is determined by taking the weighted average of the loans you're consolidating and then rounding upward to the nearest one eighth of a percent. The new interest rate can never exceed 8.25%.

• What is the length of the repayment period for the new loan? In determining the repayment period, the consolidating lender must take into account your entire education debt, not just those loans eligible for consolidation. The length of your new loan is determined by the amount of your debt. This chart demonstrates how the size of debt influences the length of repayment. Upon consolidation, many of you will have a 30-year loan.

• Can you pay off the loan early? Absolutely. Just because the length of your loan is 30 years doesn't mean you can't pay it off in 5 or 10 years. If you pay even a little extra each month, you can take years off the remainder of the loan.

Company Selection

The loan consolidation process is regulated, which means all consolidation companies must follow the same rules, so most companies have the same programs to offer. Some companies will offer small incentives from time to time. For example, you may be offered a discount if you pay via bank draft or if you pay on time for 5 years. But, for the most part, loan consolidation companies are all the same.

Regardless of whether you consolidate your loans, it is critical to understand the math behind your student loan debt. Poor understanding here can be dangerous and cost you thousands more in interest.

Consider a doctor with a debt of $120,000 and a new repayment schedule of 30 years, after consolidation (Table A). The new interest rate is 4.5%, the repayment option chosen is the standard payout option, and the minimum monthly payment on this 30-year loan is $608.02 per month.

The 30-year row assumes that you're going to only pay the minimums for the next 30 years. The 5- and 10-year rows assume that you are going to pay extra and have the debt paid off in those amounts of time.

If you only pay the minimums, one downside to consolidation is the amount of interest you will pay over 30 years. A doctor should not consolidate and only pay the minimum payments. If you choose to consolidate, then as a good standard, try to pay double the minimum payment.

Consolidation Decision

Here are two simple questions to ask yourself when making this important decision:

  • Are you financially disciplined to make the extra payments each month to be debt-free in 5 years?

If you answered yes to both questions, you should consider consolidating your student loans and paying substantially more each month toward the principal.

If you answered no to either question, you should not consolidate. Without consolidation, you will be debt-free in 10 years at the latest. It's better to not consolidate and be debt-free in 10 years than to consolidate and pay for 30 years (Table B).

Consolidation can be a great help to some, but it's not for everyone, so before you make any concrete decisions, seek the advice of a financial planner or a consolidation expert—they can lay out your consolidation options.

Brock Barnes, founder of Strategic Wealth Management, specializes in helping physicians build wealth and simplify their lives. He welcomes questions or comments at 806-793-2584 or barnes@swealth.us.