As promised, I have put together for you an example of a loan consolidation for you. Recently my brother came to me with multiple loans accruing interest at different rates. He wanted to know if the rate he would receive for consolidating his loans would be worth the switch.
I stand by that debt is something to avoid and that if you find yourself in it, your goal should be to get out as soon as you can. Finding a better rate on a loan is not an excuse for attacking a loan less aggressively or become more “ok” with debt. The purpose of this article is so that even if you do happen to find you can’t avoid borrowing (Most likely for funding tuition) you want to have your loans situated in the most logical way possible. This involves paying the least amount of dollars in interest possible.
For my brother, the situation involved various student loans as follows:
$1314 at 6.8%
$7777 at 6.8%
$2250 at 0% until October 2016 (it will then be 4.5%)
When I look at interests rates, I like to see exactly how much interest I am paying on a daily basis. This may be scary for some people, but for me it makes the situation more tangible and keeps me motivated to optimize it. To see how much a loan is costing you each day you hold on to it, simply multiply the loan balance by its interest rate, then divide this number by 365. This is the yearly interest divided by the number of days in a year.
This amount changes as you pay down the loan, this is just meant to be a quick way to asses how much a loan is actively costing you at the moment, so that you may be motivated to optimize the situation.
For the $1314 loan, we have (1314 X 0.068)/365 = 24 cents per day
$7777 at 6.8% accrues $1.45 per day, and for now, the $2250 loan is free.
So for right now, he is paying $1.45 + 24 cents = $1.69 per day in interest.
After investigating consolidation programs, he was offered to bundle it all into one big $11341 loan at 6.2%
$11341 at 6.2% would accrue $1.93 each day, 24 cents more than the previous situation. So why did the consolidation end up making the debt worse? The offered rate did not take into account the $2250 loan not yet accruing interest. If all loans were currently accruing interest, the loans consolidation would have come out closer to even.
So my brother did not make the switch. I know 24 cents a day seems like a meager win, but remember, we look at things on a ten-year time span around here. Every 24 cent per day decision is a differences of nearly $1300 over a decade. Not enough to actively work for, but quick little decisions like this that will generate passive savings have a tendency to really stack up after a while.
When dealing with multiple loans, it is also important to pay off the highest interest debt first. This may seem obvious, but some people will pay down their largest loans first because they are technically paying the most interest than on a smaller loan at a higher rate. It is easy to see a large monthly amount going to a $200,000 mortgage at 3% and think it is the biggest threat, but it is still more wise to pay down the $1000 loan at 8% first, as it will save you more in interest.
For those of you who have a few loans at high interest rates (Higher than 6-7%) you may have options for reducing your interest, especially if you have good credit. If you are lucky enough to live in a state where you can borrow, Lending Club is known to give out loans at closer to 4-5%. SOFI is an up and coming company focused on helping students with student loan debt. With good credit, you can get rates of as low at 2%.
You can also check around with friends and family. Seriously, if you have a good friend with some spare cash earning nothing in a savings account, they may be interested in earning 2-3% off a loan. Just make sure you honor the loan in a timely manner as you would with any bank or institution. You have a very trusting friend if they are willing to loan you money, you wouldn’t want to do anything to mess that up.