As a college or university graduate in Canada, you may be one of over 1.8 million people responsible for repaying student loans. And unless you have a cushy bank account, you may have concerns about your ability to handle the monthly payments.
Student loans can easily strain your budget, especially if you’ve recently left school and have to survive on a modest income. Managing student loan debt payments with food, rent, transportation, and other day-to-day expenses can be challenging.
You may have wondered whether student loan debt consolidation can provide you with some financial relief. The truth is that it can, but it’s not the most optimal solution for everyone. Other forms of debt relief may be more suitable.
In this article, we’ll explore how debt consolidation works in the context of student loan payments. We’ll also cover the pros and cons of getting a debt consolidation loan and how to know if it’s worth applying for one in the first place.
Which types of student loans are eligible for debt consolidation?
In Canada, student loans originate from one of three sources:
- Federal government – The Canadian Student Loan Program (CSLP) offers fixed and variable-rate federal loans.
- Provincial/territorial – Each province and territory offer financing to students to fund their education. An example is the Ontario Student Assistance Program (OSAP).
- Private financial institutions – Banks, credit unions, and other lending firms provide financing to students through personal loans, credit cards, and lines of credit.
In some provinces, federal and provincial loans automatically consolidate upon graduation. For example, if you live in Ontario, your OSAP loan will merge with your federal student loan. As a result, you’ll only need to make one payment each month rather than two.
Both government-issued student loans and private student loans are eligible for debt consolidation. However, you’ll face more hurdles in getting a debt consolidation loan for the former. The reason is most lending companies won’t agree to loan money to consolidate government-issued student loans.
Government student loans also offer benefits like tax breaks and access to financial assistance services. These benefits become unavailable if you transfer your balance to a debt consolidation loan (more on this later).
How does student loan consolidation work?
Debt consolidation involves combining two or more debts under a single loan. Essentially, you acquire a debt consolidation loan and use the proceeds to pay off your debts in full. Then, you pay down the balance on your new loan.
The most critical aspect of debt consolidation is securing a lower interest rate than the average rate you currently pay. Otherwise, there’s no advantage in consolidating your student loans, or any debt for that matter.
Pros of student loan debt consolidation
Here are some of the advantages of using a debt consolidation loan for student loans:
- Lower interest costs. If You obtain a loan with a lower interest rate than the one you currently pay. You’ll pay down your balance with less interest on your account.
- One fixed monthly payment. Consolidating your student loans means you no longer need to juggle multiple payments. As a result, budgeting and cash flow management will become more straightforward.
- Depending on your lender’s policy, you could negotiate to repay your loan over a long period. This means your monthly payments will decrease, putting less pressure on your budget.[MM2]
- Credit repair. Your credit score will suffer if you’ve fallen behind on your student loan payments. A debt consolidation loan will allow you to settle your remaining balances and give you a fresh start to re-establish your credit. Your credit history will gradually improve if you make timely payments on your new loan.
- Resolve other high-interest debt. You can bundle a wide range of high-interest debts in a debt consolidation loan, such as credit cards and lines of credit. Provided you can get a favourable rate, you’ll realize considerable savings in interest charges.
Cons of student loan debt consolidation
Despite the benefits of debt consolidation, there are several disadvantages to consider as well.
- High credit score requirement. To qualify for an affordable debt consolidation loan, you must possess a good credit score. What constitutes “good” credit varies from lender to lender, But, on average, it’s around 670. But on average, it’s around 670. You’ll have trouble getting your loan application approved if your credit is in bad shape.
- Loss of access to debt help programs. Government-issued student loans provide you with access to certain financial assistance programs. The Repayment Assistance Plan (RAP) is the most notable; it can eliminate interest charges on your loan and lower monthly payments. However, if you transfer your government student loans to a debt consolidation loan, you’ll no longer qualify for this service.
- Stable income requirement. Lenders who issue debt consolidation loans want assurances that you earn a steady income. Otherwise, you risk defaulting on your payments. If you’re a young and inexperienced college graduate, you may have yet to secure a stable, well-paying job.
- Loss of tax deductions. The interest your pay on a government student loan qualifies as a tax-deductible expense. However, debt consolidation using a loan from a private lender will eliminate this tax break.
- Higher interest rates. As mentioned, you’ll need good credit to get a debt consolidation loan at a low interest rate. If lenders perceive you as a risky borrower, you’ll be limited to loans with steep rates. Naturally, a 30% interest rate defeats the primary purpose of getting a debt consolidation loan: to save on interest costs.
- Collateral requirement. Some lenders will require that you pledge an asset as collateral before approving your loan application. Not surprisingly, if you own little or no assets, this will be a significant roadblock in consolidating your student loans.
- Restrictions on government-issued student loans. Many lenders are unwilling to loan money to borrowers who want to consolidate government-backed student loans.
Debt management program (DMP) – can it help lower student loan payments?
A debt management program (DMP) is a debt relief service that credit counselling agencies offer. By enrolling in a DMP, a credit counsellor will roll your unsecured debts into a single monthly payment plan, much like a debt consolidation loan. They’ll also negotiate with your creditors to eliminate or reduce your interest charges.
However, a DMP isn’t well-suited for dealing with student loan debts.
The federal and provincial governments typically don’t work with credit counselling agencies to bundle student loans. The only exceptions to this rule are if your student loans are in collections or you failed to qualify for a loan rehabilitation program. There’s usually no interest relief either, especially on the federal portion of the loan.
What to consider before consolidating your student loans
Student loan debt consolidation can be a wise financial move under the right circumstances. But for many people, the costs outweigh the benefits. Ultimately, it comes down to what you can afford to pay. If you fail to qualify for a low interest rate, applying for a debt consolidation loan doesn’t make financial sense.
Let’s assume your student debt consists only of government-issued loans. In that case, a debt consolidation loan is unlikely to benefit you in any meaningful way, as interest rates on government loans are low already.
Alternatively, let’s say your debt consists mainly of private student loans. In this scenario, bundling these loans may be worthwhile. Interest rates on private student loans tend to be higher, so they’re better candidates for debt consolidation. But you’ll need to crunch the numbers to be sure.
In addition, you need to assess the impact of debt consolidation on your other debt obligations. Will consolidating your student loans with your credit card debts save you money on interest overall? Or is it cheaper to continue repaying your existing debts separately?
Consumer proposal – a superior way to consolidate student loan debt
One glaring problem with student loan debt consolidation is that you’re only swapping out one form of debt for another. Unless you can find a lender kind enough to offer you a super-cheap interest rate, there’s little to gain by consolidating. In fact, doing so may only exacerbate your debt problems if you’re already struggling financially.
A better way to consolidate student loans and other unsecured debts is through a consumer proposal. Unlike a typical loan, you’ll have the opportunity to negotiate with your creditors to repay only a portion of what you owe. Plus, you won’t have to pay any interest charges on your remaining balance!
To include government-issued student loans in a consumer proposal, seven years must have passed since you left school. However, a consumer proposal can settle other unsecured debts, leaving more room in your budget. As a result, you’ll have an easier time paying back your student loans.
A Licensed Insolvency Trustee can provide free advice if you need guidance on how to deal with your student loans. At David Sklar and Associates our trustees have been helping people tackle their student loan debt for over 20 years. We can craft a solution that considers your needs and goals regardless of your debt situation. Trust us – we’ve seen it all!
Contact us online today to book a free, no-obligation consultation and get started on your journey toward financial freedom.
Photo by Vlada Karpovich