You may know what it means to consolidate student loans. Or, you may have it confused with refinancing. But student loan consolidation and refinancing are important tools for managing your debt.
Let’s look at three types of borrowers for whom refinancing or consolidating makes sense.
3 times it makes sense to refinance or consolidate loans
First thing’s first: Do you know the difference between consolidating and refinancing?
When you consolidate student loans — such as with a Direct Consolidation Loan — you group multiple loans into one. The interest rate you receive on consolidation student loans may be the average of the previous loans’ rates. You may consolidate to switch from a variable rate to a fixed rate or change your repayment term.
Refinancing is only available through private lenders. When you refinance, you get a new loan to pay off your other student loans. You may refinance to get a loan with a shorter or longer repayment term or lower interest rate.
As a result, refinancing may save you more money over your student loans.
Keep in mind the federal government’s Direct Loan Consolidation program can only group federal student loans together. Private lenders can consolidate and refinance both federal and private student loans.
Of course, there are are other differences in federal and private consolidation. The important thing to know here is why someone would want to consolidate loans at all.
That’s where our three sample borrowers come into play:
1. A small-business owner with big debt
Consider this: A dentist has six federal loans from her time spent in college and dental school. She’s having trouble keeping track of and making payments on six student loans since she started her own business.
Consolidation: She decides to consolidate her student loans using a Direct Consolidation Loan. That allows her to make a single monthly payment each month.
Consolidation also happens to allow her to qualify for Pay As You Earn (PAYE). Further, the PAYE plan limits her student loan bill to 10 percent of her discretionary income. That helps her a lot, since she’s taking a small salary while her new business grows.
The big picture: Rising education costs may be deterring millennials from starting businesses, according to the Kauffman Foundation.
Entrepreneurs tend to have a higher-than-average debt-to-income ratio. For them, smaller monthly payments on student loans over a longer term may make sense. That way, they can divert more money to a business that, if successful, could pay off their loans in the long run.
2. A recent grad moves into public service
Consider this: A recent grad has five federal loans. Unfortunately, her salary at a nonprofit won’t allow her to pay down her higher-interest accounts.
Consolidation: She decides to take out a Direct Consolidation Loan. Although it won’t necessarily lower her interest rate, it will have a weighted average of her previous five loans’ rates.
Our borrower also decides to switch to an Income-Based Repayment (IBR) plan. That extends her repayment term, lowering her monthly payments.
With $55,000 in debt, the IBR plan is helpful because it puts her on the track to loan forgiveness. After all, she’s hoping to qualify for Public Service Loan Forgiveness (PSLF), which will forgive her debt after 10 years.
The big picture: While the future of PSLF may be uncertain, it’s important for low-salaried civil servants to choose a long-term repayment strategy that has a path to forgiveness. This is particularly true if their debt exceeds their ability to pay it. Consolidation of student loans could be just the solution.
3. A high-earner with an excellent credit score
Consider this: A young attorney has three federal loans and three private loans. Tired of going to work with student loans on his mind, he turns to refinancing. With a six-figure salary and excellent credit score, he knows he can save a lot of money by refinancing.
Refinancing: Our lawyer takes his loan portfolio to a private lender that his colleagues recommend. He isn’t worried about losing federal loan protections since he found a private lender that offers forbearance in case he loses his job.
The lender consolidates and refinances his six loans into one. Because of his excellent credit, he qualifies for a lower interest rate. That will save him thousands on his six-figure debt.
The big picture: Refinancing isn’t for everyone. But with a great credit score, you can qualify for low rates that lower the long-term costs of your loan.
If you have federal and private student loans, refinancing can help you take control of your debt — as long as you don’t mind losing access to federal loan protections.
Should you consolidate or refinance your loans?
Many student loan borrowers can benefit from refinancing or consolidating. If you want to lower your monthly payments, you can refinance to extend your repayment term. If you’re drowning in federal student loans, you can consolidate into a single monthly payment.
If you’re uncertain whether you’ll benefit from either repayment strategy, do further research. To start, try this calculator. It can help you decide whether refinancing or consolidating is a better option for you.
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