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If you’re looking for ways to simplify your education debt or pay it down faster, student loan consolidation can help. According to the latest student loan debt statistics, 12 million federal loan borrowers have Direct Consolidation Loans, and many others have refinanced their debt with private lenders.
For many, the idea of consolidating student loans is appealing. But while you might get some benefits from consolidating, you might also lose some in the process. This guide will walk you through how student loan consolidation works and how to decide if it’s right for you.
How student loan consolidation works
Student loan consolidation is the process of rolling one or more loans into a new loan to take advantage of a single monthly payment, a potentially lower interest rate, or special federal loan protections.
There are two main types of student loan consolidation: federal loan consolidation through the Direct Loan Consolidation Program and private student loan consolidation, more often called refinancing.
Direct Loan Consolidation
The Direct Loan Consolidation Program allows you to combine one or more federal student loans into one new loan under the Direct Loan Program. You don’t need to undergo a credit check to qualify for federal student loan consolidation, but you can’t consolidate a defaulted loan unless you make at least three consecutive monthly payments on it.
If you have multiple federal loans, consolidating them can simplify your debt repayment by combining them into one. Plus, if your loan isn’t already part of the Direct Loan Program, consolidating could qualify you for certain repayment plans and forgiveness programs that you weren’t previously eligible for.
For example, if your federal loan is through the Federal Family Education Loan (FFEL) Program, you don’t qualify for the Public Service Loan Forgiveness (PSLF) program, and you can only choose one of the four income-driven repayment (IDR) plans. But if you consolidate your FFEL Loans with a Direct Consolidation Loan, you’ll have access to PSLF and all four IDR plans.
Also, parents can consolidate their Parent PLUS Loans and get access to Income-Contingent Repayment.
Student loan consolidation through the federal government can also allow you to extend your repayment period from 10 years to up to 30 years, depending on your loan balance and the payment plan you choose.
Lastly, it resets the clock on deferments and forbearances you’ve already taken on your current loans. “Federal loans have up to three years of deferments and forbearances for things like economic hardship and unemployment,” said Mark Kantrowitz, a student loan expert. “If you consolidate your loan, that’s a new loan with a new set of deferments and forbearances.”
While federal student loan consolidation offers some benefits, saving you money isn’t one of them. “With federal consolidation, you’re not actually changing the cost of the loan,” said Kantrowitz. “The new loan has an interest rate that’s based on the weighted average of the interest rates on the loans that you’re consolidating, rounded up to the nearest one-eighth of a percent.”
As an example, let’s say you have the following loans:
- Loan A: $10,000 balance, 4.50% APR
- Loan B: $15,000 balance, 5.25% APR
- Loan C: $7,500 balance, 6.00% APR
Your weighted average interest rate for these three loans is 5.19%, which would be rounded up to 5.25% for your new Direct Consolidation Loan. This means that in most cases, you’ll end up paying more interest over the life of the new loan if you consolidate.
And while consolidating through the Department of Education resets the clock on deferments and forbearances, it does the same thing to your progress toward loan forgiveness through PSLF and IDR plans.
Private student loan refinancing
Instead of consolidating through the federal government, you can choose to refinance your student loans through a private lender.
“With a private consolidation loan, it’s a new loan with a new interest rate based on your current credit score and the credit score of a cosigner if any,” said Kantrowitz.
If you or your cosigner’s credit score isn’t good enough, though, you might not qualify for a lower interest rate than what you’re currently paying.
The biggest benefit of refinancing your student loans is the possibility of scoring a lower interest rate. Student loan refinancing lenders typically offer both fixed and variable interest rates to give you more options. If you can get a lower interest rate, you could end up paying off your student loans faster and with less interest.
For example, let’s say you just left school and will be paying an average of 5.25% on $30,000 worth of federal student loans over a 10-year period. You check your rates for refinancing and get a fixed rate of 4.00%.
If you remained on a 10-year repayment plan on the new loan, you’d save $2,177 in interest over your repayment period.
As with federal student loan consolidation, you’ll also be able to reduce the number of monthly payments you have to keep track of. Plus, you’ll usually have a few repayment terms from which you can choose, giving you even more flexibility as you pay down your debt.
If you think you’ll want to take advantage of IDR plans and PSLF, refinancing your federal student loans isn’t a good idea. That’s because there’s only one major student loan refinancing company that offers an IDR plan: the Rhode Island Student Loan Authority. No major student loan refinancing companies offer student loan forgiveness.
Another drawback to refinancing is the credit check requirement. If your credit and income aren’t in good shape, you might have a hard time getting approved. Of course, you can get a cosigner. But it can be tough to convince someone to cosign long-term debt, even with the small possibility of getting removed from the loan at some point in the future through a cosigner release program.
How to consolidate your student loans
If you’re considering refinancing your student loans, start the process by comparing several student loan refinancing companies. You’ll be able to see what rates and benefits they might offer you. And while private lenders don’t require a hard credit check to show you tentative rate offers, they will check your credit when you officially apply.
If you’d rather consolidate your federal loans through the Direct Loan Consolidation Program, you can start the application process on the Federal Student Aid (FSA) website. To apply, you’ll need to log in to your FSA account and provide the following information:
- Permanent address
- Email address
- Phone number and the best time to reach you
- Information about your current federal loans
- Your adjusted gross income from your latest tax return or documents proving your current income
Applying for the Direct Loan Consolidation Program is free, and the application process takes about 30 minutes. During the process, you’ll select a consolidation servicer, which will be your point of contact until you get a final decision. Approval isn’t immediate or guaranteed, so keep making payments on your current loans until you hear back from the servicer.
Should you try student loan consolidation?
There’s no guarantee that student loan consolidation will help you, but it’s worth knowing what your options are and how they can help you with your student loan repayment.
If you have federal student loans and want to get or retain the benefits of the Direct Loan Program, consolidating your loans through the Department of Education might be a good idea.
But if you don’t plan on taking advantage of federal student loan benefits and have great credit and income (or a cosigner who does), you might want to try refinancing to see if you can get a lower interest rate on your loans.
Whether you choose to consolidate or refinance your student loans, be smart about how you do it, especially if you have some loans with low rates and others with high rates.
“If you have high interest rates and low interest rates and the interest rate you get with refinancing is between those,” said Kantrowitz, “it makes sense to refinance the higher-rate loans and leave the others with a lower interest rate.”
And if you’re planning on consolidating, Kantrowitz recommended leaving higher-rate loans out of the consolidation process. That way, you can target them for faster repayment. “If you pay off the higher-interest loan in a few years, you may be saving more than you would if you consolidate,” he said.
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