Should You Consolidate Student Loans?

A college education doesn’t come cheap, as 44 million Americans can attest.

Collectively, they have borrowed $1.75 trillion to score a diploma, and paying it back hasn’t been easy. About 7% default on their student loans and though the average repayment time varies by the amount owed, it takes an average of 20 years to pay off student loans and might take as long as 30 years.

Those with student loans owe an average of $37,853 and their payments are about $500 a month. That is a sizeable and unwelcome graduation gift so it’s important to know how to minimize the damage.

If the money you borrowed was all federal loans, you can find easier repayment options by applying for a Direct Consolidation Loan.

If some or all of your student loans were from private lenders, you will have to use a refinancing program to achieve similar results.

What Is Student Loan Consolidation?

Consolidation is a way to make repaying student loans more manageable and possibly less expensive. You combine all your student loans, take out one big consolidation loan, and use it to pay off all the others. You are left with one payment to one lender every month.

The typical student borrower receives money from federal loan programs every semester in school. It often comes from different lenders, so it is not unusual to owe money to 8-10 separate lenders by the time you graduate. If you continue borrowing for graduate school, add another 4-6 lenders to the mix.

Each of these student loans has its own due date, interest rate, and payment amount. Keeping track of that kind of schedule is complicated and part of the reason so many have defaulted. It’s also why student loan consolidation is such an attractive solution.

Federal loans can be consolidated in the Direct Consolidation Loan program. The U.S. Department of Education pays off your existing student debt and issues you a new loan that has a fixed interest rate. That rate is derived by taking the average of the interest rates on all federal loans and rounding the rate up to the nearest one-eighth of a percent.

Though this method will not lower the interest you pay on federal loans, it will keep open all repayment and forgiveness options. Some lenders do make it possible to reduce the interest rate by making direct payments or by qualifying for a reduction by making on-time payments over an extended period of time.

Difference Between Student Loan Consolidation and Refinancing

Refinancing student loans is similar to the Direct Consolidation Loan program in that you bundle all your student loans into one loan and make a single monthly payment, but there are important differences that you should look at before making a decision.

Refinancing, sometimes called private student loan consolidation, is primarily for private loans and can only be done through private banks, credit unions, or online lenders. If you borrowed from both federal and private programs and want to consolidate the whole batch, that only can be done through a private lender.

The major difference between refinancing and Direct Loan Consolidation is that with refinancing you negotiate a fixed or variable interest rate that should be lower than what you were paying for each loan individually. The lenders take into account your credit score and whether you have a cosigner in determining your interest rate. This could save you money if your credit score is better than when you took out your original loans.

However, if federal loans are part of your refinancing, you lose the repayment options and forgiveness programs they offer, including deferment and forbearance. Those last two items can be crucial if you run into financial complications while repaying your loans.

Although the terms often are used interchangeably, for the purposes of this article, consolidation refers to federal loan programs and refinancing refers to using private lenders.

Pros of Student Loan Consolidation

Consolidating your student loans has several advantages.

• Simplicity: If you have multiple student loans with different financial institutions, consolidation converts that to a single monthly bill.
• Potentially lower monthly payments: Getting a new loan gives you the option of paying it off over a longer term. That means you’ll owe less each month.
• Flexibility: A Direct Consolidation Loan application allows flexible loan options, including graduated repayment plans and income-driven repayment plans, which base your monthly payment amount on your income. That can make your loans more affordable.
• Federal protections: A Direct Consolidation Loan allows you to keep access to federal deferment, forbearance, and federal loan forgiveness options. This is not true of refinancing.
• Fixed interest rate: A Direct Consolidation Loan will allow you to change variable-rate loans to a fixed interest rate for the life of the loan.
• Forgiveness options: If you consolidate loans other than Direct Loans, you may gain access to forgiveness options that can lower the amount you’re paying or forgive a significant amount of what you owe.
• Easy application: It’s free to apply, and there is no origination fee for the new loan.
• Improved credit: Consolidation can help you come back from a student loan default, which will help your credit rating.

Cons of Student Loan Consolidation

There are two sides to every story and here is the other side to consider before going into the Direct Loan Consolidation Program:

• Pay more interest over time: If you consolidate and extend the loan term, you could pay a lot more in interest. The longer you wait to pay off the loan, the more interest you end up paying. Also, if you’re still paying on a student loan for 20-25 years, it could hinder or even block opportunities to buy a home, relocate, invest in a business, or even buy a new automobile. Paying off a loan as quickly as possible saves time and money. It’s as simple as that.
• Rounded-up interest rate: Direct loan consolidation adds one-eighth of 1% to the weighted average interest rate. The new rate is determined by a weighted average of all the other rates, which considers the amount owed, and adds 0.125%. If your larger loans have a higher rate, then the weighted average will be a little higher than a simple average.
• No private loan consolidation: Student loans from private lenders or institutions can’t be part of the Federal Consolidation loan program. On the other hand, certain private lenders allow loan consolidation that could include federal loans, but the interest rates are usually much higher on private consolidations.
• Lose some benefits: If you have made payments toward Public Service Loan Forgiveness, consolidating your loans will restart the clock on qualifying. Also, you may lose benefits on other programs, notably Perkins Loans if the Perkins loan becomes part of a Federal  Direct Consolidation Loan. Read all the terms and conditions of your loan before consolidating.
• Lost “grace” period: Borrowers typically get a six-month window before having to start repaying student loans. That goes out the door when you consolidate your loans. You typically start paying two months after your loan consolidation is approved.
• Lender benefits gone: Some lenders give reduced interest rates or principal reductions if borrowers meet certain conditions. Those benefits are lost when your student loans are consolidated.
• No do-overs: You can only consolidate student loans one time. If interest rates fall after you consolidate, tough break! You’re stuck with the interest rates you agreed to during consolidation.
• Unpaid interest: If you have any unpaid interest on your current loans, that interest is added to your principal balance when you consolidate. So, you’ll pay interest on the higher principal balance.

Federal Student Loan Consolidation

Let’s take a deeper dive into Direct Consolidation Loans.

Who is eligible? Most federal student loans are eligible for consolidation, including Direct Loans and FFEL Program Loans. Generally, you are eligible to consolidate student loans after you graduate, leave school, or drop below half-time enrollment.

How do you apply? Applications can be submitted online. It takes about a half-hour to select the loans you want to consolidate and select the new monthly repayment plan. You’ll need to provide a verified Federal Student Aid ID, personal details, financial information, and additional loan information. No application fee is charged.

What are additional potential benefits for those who consolidate their student loans? If your consolidation includes Direct Loans, all of the loans you consolidate have access to protections and benefits such as Public Service Loan Forgiveness (PSLF), which can eliminate the balance of your Direct Loans after 10 years of payments while working full-time for a government, tax-exempt nonprofit organization, and some other not-for-profit organizations.

How will my interest rate be affected? Direct loan consolidation adds one-eighth of 1% to the weighted average interest rate.

If I have an existing consolidation loan, can I consolidate it again? Only if you include an additional eligible loan in the consolidation.

Can consolidation include private loans? No.

Private Student Loan Refinancing

A private student loan refinancing accomplishes some of the same goals as federal student loan consolidation and even has the advantage of possibly providing a lower interest rate. As with consolidation, refinancing will provide predictable monthly payments, and you may choose to lengthen the repayment term to lower monthly payments. However, there are significant differences and potential drawbacks.

Refinancing lets you merge private and federal student loans into a single private loan through a private lender or bank. Since your credit scores may be better than when you were a student getting the original loans, lenders may offer lower interest rates, and you may choose either fixed or variable rates.

Potential benefits include:

Refinancing both federal and private loans: Federal loan consolidation doesn’t offer that option.

Lower monthly payments: Lower interest rates may lower your monthly.

Quicker payback: You may choose to use the lower interest rates to shorten the term of the loan, paying off your loan sooner without increasing monthly payments. This could save you thousands in interest payments over the life of the new loan.

On the other hand:

Say goodbye to federal loan protection benefits: Public Service Loan Forgiveness or Income-Driven Repayment Plans, which help federal borrowers during tough times, don’t apply to private refinancing.

You may need a co-signer to get better rates: Credit history is a part of private loans, unlike federal student loans. If your credit rating isn’t good, you may need help getting a good interest rate.

Possibly shorter repayment terms: Many of the federal repayment plans have repayment periods of up to 20-25 years. Many private lenders give you 10 years to pay back your loan, though some do extend the term up to 25 years.  

Tax implications: If you refinance federal student loans along with non-student loans into a personal loan consolidation, the new loan may no longer qualify for a student loan interest tax deduction. Check whether that would be the case for you if you usually claim this deduction.

As with any commercial loan, your credit rating is a big factor in the terms lenders will offer. A good credit score, stable income, and your debt-to-income ratio – under 43%, preferably – will play a role.

Key Considerations Before Consolidating or Refinancing

You need to consider your current loan terms and how they compare to the available consolidation or refinance options. How much, if any, would the new interest rate affect your monthly payment? Are you close enough to paying off your loans that a change wouldn’t help a great deal? If you choose a longer payback period, how much more will you have to pay in interest before paying off the loan?

A hidden benefit of consolidation is that it can improve your credit rating. Consolidating multiple debts into a single loan with a lower payment improves your debt-to-income ratio, which can boost your credit score.

How to Decide if Consolidation or Refinancing is Right for You

So, what’s your goal? If you want to simply and stabilize your finances by turning multiple loans into a single payment while maintaining access to income-based repayment options and federal protections, a Federal Direct Consolidation Loan is designed for that. Consolidation may offer the chance to lengthen the term of the loan, which will lower your monthly payment if that is important for you. (Remember, that will cost more in interest over the life of the loan.)

However, if your need to get your debts organized includes private loans, and if getting a lower interest is important to making your student debt affordable, you’re looking at private refinancing. Also, private refinancing may offer variable-rate loans, which may further lower interest rates in the short term, though there’s no guarantee they won’t rise later.

The U.S. Department of Education offers a loan simulator to help you determine whether the consolidation numbers work for you. Private lenders often have loan calculators that can provide cost and savings information concerning refinancing.

Alternative Options to Consider

Consolidating is a viable answer for many with student loans, but it’s not the only federal program that helps those struggling to repay what they borrowed.

Income-Driven Repayment (IDR) Plans for those with federal student loans offer lower monthly payments because they are based on your income, which may be quite small after you leave college, particularly if you have a hard time finding a job. They’re re-evaluated annually and adjusted as your income fluctuates. However, no matter how much your pay goes up, IDR payments will never be larger than if you’d chosen the 10-year Standard Repayment Plan. IDR recipients also are eligible for loan forgiveness after 20 or 25 years. IDR is a good choice if you expect your pay to stay low or your family to grow.

The Department of Education offers student loan forgiveness for several categories of borrowers. The most common program is Public Service Loan Forgiveness in which those who teach, are government workers, work for a nonprofit or in a medical profession, or have a disability can have all or part of their student loan debt forgiven.

If you’re in a temporary financial predicament, you may request student loan deferment or forbearance. If you are granted deferment or forbearance, you can temporarily cease payments. However, interest will accrue during this time, so you’ll pay more over the life of the loan. Situations where deferments may be granted include your undergoing cancer treatment, experiencing economic hardship, enrolled in school or a graduate fellowship, and performing military service. Forbearance is possible for those serving in AmeriCorps, serving in the National Guard, or doing Department of Defense work that would qualify for partial loan forgiveness and working as a teacher.

Charting Your Course with Student Loan Consolidation

Like all debt, student loans can become a serious financial drag, so it makes sense to find a way to minimize the problem. Consolidation is worth careful exploration. As with any big decision, getting expert advice is smart, so consider consulting a financial advisor who can offer insights about your financial circumstances that you never considered.

For nuts-and-bolts information about student loan debt, visit the Department of Education’s studentaid.gov website.