Editor’s Note: In response to the coronavirus pandemic, as of March 13, 2020, the Trump Administration has halted interest payments on federal student loans. Please note that this applies to federally held student loans only and may not apply to your private student loans. Also note that student loan payments are still required, however your entire payment will now be made toward the principal of the loan. Check with your student loan provider for more information.
Let’s face it, student loans can get downright confusing. Obviously, you’re required to pay them back, but wading through all the new terminology and repayment options can feel overwhelming.
Unfortunately, this is some really important stuff. Making the wrong decisions could end up costing you a lot more than necessary – sometimes thousands of dollars more.
If you recently graduated from college, you’ve probably been getting letters from student loan servicing companies asking if you’d like to consolidate your student loans. It’s natural to wonder if this is a good idea or not.
Don’t worry. We’re here to walk you through it.
In this piece, we’ll explain what it means to consolidate student loans, compare student loan consolidation with student loan refinancing, and help you decide if consolidating your student loans is the right move for you.
Let’s get started!
What Is Student Loan Consolidation?
Student loan consolidation is a process in which you combine all (or some) of your student loans into a single new loan. The new loan is then scored with an interest rate that is equal to the weighted average of the loans you just combined.
Whew. Did you get all that?
If you’re thinking about consolidating your student loans, what you’re usually considering is taking out a Federal Direct Consolidation Loan. Again, this is a new loan that combines all (or some) of your federal student loans into a single new loan – regardless of which servicer currently holds each individual loan. This process can only be completed once with each loan, and your new interest rate is determined by the weighted average of the loans you combine.
Here’s an example: Let’s assume you have 3 federal student loans of $5,000, $10,000, and $15,000, respectively. The two smallest loans have an interest rate of 3.76% while the largest loan has a rate of 4.45%. By consolidating, you’d have a new loan totaling $30,000. Because the interest rate on the new loan is the weighted average of the loans you combine, your new loan’s rate would be 4.11%.
Benefits of Consolidating Your Student Loans
So, why would you even want to consolidate your federal student loans? Here are some reasons student loan consolidation may be for you:
- Convenience – During your time at college, chances are good you took out more than one student loan to pay your way. In fact, you probably took out new loans each semester. Each of those loans comes with a separate bill. What’s more, with multiple loans to deal with, there’s a good chance that they may be handled by several student loan servicing companies. By consolidating your federal student loans, you’ll have just one student loan payment to make each month – provided you consolidate all your loans and don’t have private loans as well.
- Retain Eligibility for Federal Protections and Repayment Programs – Unlike refinancing your loans through a private lender (which we’ll discuss later), consolidating your student loans typically helps you remain eligible for federal student loan protections and repayment programs – such as the Public Service Loan Forgiveness program (PSLF) and others.
- Lower Monthly Payments – If you are able to extend your repayment term (the amount of time you have to pay back your loans), this could result in lower monthly payments.
- Choosing a Servicer – When you consolidate student loans, you have the option of choosing your loan servicing provider. For instance, if you’d like to switch from FedLoan Servicing to another servicing provider, you have that option.
Disadvantages of Consolidating Your Loans
- You Can Only Consolidate Each Loan Once – As I mentioned above, each individual loan is eligible to be consolidated only once. Be sure you do it right the first time.
- Longer Repayment Terms – Extending the length of your student loan can help lower your monthly payment, but it will cost you more money over the long run because you’ll end up paying more in interest.
- May Not Get Best Rate Available – Because the interest rate on your new consolidated loan uses the weighted average of your previous rates, you may not get the best rate available. If you’re looking for the best interest rates, refinancing through a private lender may be a better option. Here’s a list of some of the best student loan refinancing rates this month.
- Outstanding Interest Added to Principal – If you chose not to pay interest on your loans while in school, any outstanding interest is added to the principal of your loan at the time you consolidate. This is important because it increases your principal balance, which means you’ll accrue more interest on the loan than if you did not consolidate.
- Loss of Qualifying PSLF and IBR Payments – If you’ve already made payments on your loans and plan to use the PSLF or IBR repayment programs, any payments made prior to consolidating will not count toward meeting the qualifying payment requirements.
Student Loan Consolidation vs. Student Loan Refinancing
If consolidating your loans doesn’t seem like the right fit, refinancing your student loans may be a better option. Refinancing provides many of the same benefits as consolidation with a few big differences.
When you refinance student loans, you do so through a private lender. Like with student loan consolidation, refinancing allows you to combine multiple loans into a single loan. This simplifies the repayment process and can provide other benefits as well.
The biggest benefit to refinancing your student loans is that it might provide you with a significantly better interest rate than consolidation. Instead of using a weighted average, with a student loan refinance, you’ll receive an interest rate based on your creditworthiness. This rate has the potential to be lower, or possibly higher, than the weighted average you’ll receive through a direct consolidation loan.
Additionally, both federal and private loans are allowed to be refinanced, and you can refinance student loans even if you’ve already consolidated them. Keep in mind, though, that refinancing through a private lender means you’ll give up certain federal protections and repayment programs – including your eligibility for IBR and PSLF. So, it’s important to do your research on whether or not you’re even eligible for these programs before making any decisions.
With that said, refinancing your student loans could potentially save you thousands in interest over the life of your loans. If you’re interested, Credible is an excellent place to compare rates from multiple lenders all at once. The process takes just a few minutes and is super simple to complete. It’s definitely worth checking out!
If you used federal student loans to help pay for college, consolidating your loans may be a good option for you. Combining multiple loans into a single new loan makes repaying your loans infinitely more convenient. Plus, using a direct consolidation loan keeps most federal protections and repayment options on the table for you.
On the other hand, if the idea of simplicity and convenience appeals to you but you’re concerned about finding the best rate, refinancing your student loans could also be an option. Although most borrowers won’t be affected, keep in mind that refinancing through a private lender means you may lose your ability to apply for PSLF and other income-based repayment options.
Regardless of which option you choose, be sure to do your research before making any final decisions. Good luck and thanks for reading!