I haven’t met a single person with student loans who doesn’t want them gone as soon as possible. It’s hard enough to start a career or raise a family, and when a large chunk of your income is going toward student loans every month, it can feel downright impossible.
To help ease the burden of student loan payments, many borrowers opt to consolidate or refinance their student loans. Both options have the potential to help you pay your student loans off quicker and pay less interest along the way, but there’s a lot of confusion around how they work, how they differ, and whether they’re right for you.
By the end of this post you will understand both options and have a good idea whether one, or both, are right for you.
The terms student loan consolidation and student loan refinancing are often used interchangeably, but they actually mean two very different things, and they have very different sets of pros and cons. Lenders often add to the confusion by using the term consolidation when they’re actually talking about refinancing.
So before we dive into the specifics of each option, let’s first clear up what they are.
Student Loan Consolidation: The Basics
Student loan consolidation refers specifically to the federal student loan consolidation program, a process through which you can combine one or more federal student loans into a single Direct Consolidation Loan. You cannot use this program with private student loans. Refinancing, on the other hand, is done by private lenders. Unless you’re dealing directly with the U.S. Department of Education, you’re talking about refinancing, not consolidation.
We’ll get into the details below, but the primary reason to consolidate your federal student loans is to qualify for beneficial income-driven repayment plans you wouldn’t otherwise be eligible for. And the major downside is simply that consolidating won’t get you a lower interest rate, which is often a big point of confusion.
The Benefits of Student Loan Consolidation
Given that consolidation won’t improve your interest rate, why should you consider consolidating your federal student loans? How can it benefit you?
Here are three of the biggest reasons to consider consolidating your federal student loans.
1. You can qualify for better income-driven repayment plans
The government offers a number of income-driven repayment plans for federal student loans, and these plans are a real bargain for three main reasons:
- Your monthly payment is determined by your income, which means it will decrease during periods where your income is low.
- They all offer some kind of forgiveness as long as you make the required payments for a certain number of years.
- If you work for a qualifying nonprofit or government organization, these repayment plans qualify you for Public Service Loan Forgiveness, which takes even less time and offers more forgiveness.
The catch is that only Direct federal student loans are eligible for some of these repayment plans. Federal Family Education Loans (FFEL), which were all given out prior to 2010, are only eligible for income-based repayment (IBR), which is certainly good but often not as beneficial as Pay As You Earn (PAYE) or Revised Pay As You Earn (REPAYE).
So, if you would otherwise be eligible for those better repayment plans, you can consolidate your FFEL loans and turn them into Direct Loans, thereby opening up your eligibility. And keep in mind that you can consolidate a single loan all on its own, so you don’t need multiple FFEL loans to take advantage of this.
If you wouldn’t otherwise be eligible for those repayment plans, or if you already only have Direct Loans, then consolidation won’t help you here.
2. You can lock in low, fixed interest rates
Prior to July 1, 2006, most federal student loans were issued with variable interest rates that reset each year. Since then, all federal student loans have been issued with fixed interest rates.
If you have older loans with variable rates, consolidating them now can lock in a relatively low, fixed interest rate.
For example, according to Nelnet, variable rate federal student loans currently have interest rates ranging from 2.05% to 3.80%, depending on the type of loan and year of disbursement. By consolidating and locking in those low rates, you can ensure that your loans won’t get more expensive over time if interest rates rise.
3. You can get your loans out of default
If your federal student loans are in default, which typically means that you have missed payments for 270 days, you can consolidate your loans to get out. This can be an incredibly effective way to avoid the negative consequences of default, such as your loan immediately being due in full, taxes and wages potentially be garnished, and a big hit to your credit report, among others.
The catch is you can typically only use it once in your lifetime. So you should be confident that you won’t default again in the near future before proceeding. Otherwise, you may want to consider alternative ways to get out of default, such as rehabilitation.
The Downsides of Student Loan Consolidation
While all of the above are good reasons to consider consolidating your federal student loans, here are four things to watch out for.
1. You Won't Get a Better Interest Rate
Consolidating your federal student loans won’t improve your interest rate. In fact, it’s likely that your interest rate will increase by just a tiny bit.
When you consolidate, the interest rate of your new loan is the weighted average of all of the loans included in the consolidation, rounded up to the nearest ? percent. What that means is that at best you’ll end up with the same combined interest rate that you had before, and at worst your interest rate will increase by about 0.125%.
You can use the following calculator to see what your interest rate would be after consolidation: FinAid Loan Consolidation Calculator
The bottom line, though, is that student loan consolidation is NOT a route to a better interest rate. You need to refinance if that’s what you’re after, and we’ll talk more about that below.
2. You won’t be able to target your highest interest loans first
If you have two federal student loans with very different interest rates, you can pay them off faster and save yourself money by putting extra payments toward the loan with the higher interest rate first. But if you consolidate those two loans together, you end up with a blended interest rate and lose the ability to pay off the higher-interest loan quicker.
In this type of situation, it can make a lot of sense to consolidate those loans separately. Doing so would preserve the condition of having one high-interest rate loan and one low-interest rate loan, and would therefore allow you to keep prioritizing the high-interest rate loan.
3. You’ll lose any progress you’ve made toward qualifying for loan forgiveness
One of the benefits of enrolling in an income-driven repayment plan is the opportunity to have some of your student loan balance forgiven. Basically, with each plan you have to both be enrolled in the plan and make your minimum payment for a certain number of years. If you still have a balance at that point, it will be forgiven.
Here’s a quick overview of how long it takes to earn forgiveness with each repayment plan:
- Income-Based Repayment = 20-25 years
- Pay As You Earn = 20 years
- Revised Pay As You Earn = 20-25 years
- Public Service Loan Forgiveness = 10 years
Keep in mind that Public Service Loan Forgiveness is the only program that offers tax-free forgiveness. In all other cases, the amount of money forgiven would be considered taxable income.
If you’re already enrolled in an income-driven repayment plan and have made progress toward forgiveness, consolidating your loan means you’re likely starting over from scratch.
Depending on how much progress you’ve already made, and whether you could qualify for quicker forgiveness after consolidating, this might be a reason to avoid it.
4. Watch out for Parent PLUS loans!
Parent PLUS loans are federal student loans taken out by parents, and they are not eligible for the most generous income-driven repayment plans, even after consolidation.
What that means is that you need to be very careful NOT to mix Parent PLUS loans with other loans when consolidating. You should always consolidate them separately, if at all, to make sure that your other federal student loans remain eligible for the best income-driven repayment plans.
When Student Loan Consolidation Makes Sense
In general, federal student loan consolidation can make a lot of sense when you have one or more FFEL loans and your debt-to-income ratio is high, meaning you stand to significantly benefit from one of the more generous income-driven repayment plans.
It may also make sense if you have older, high-interest, variable rate loans and want to lock in a low, fixed interest rate.
Just be careful not to mix high-interest loans with low-interest loans, and not to consolidate Parent PLUS loans with other student loans. And make sure you’re not giving up on significant progress you’ve already made toward forgiveness on your current loans.
How to Consolidate Your Student Loans
If you’d like to consolidate your federal student loans, you can start the process here: Direct Consolidation Loan Application.
Student Loan Refinancing: The Basics
Student loan refinancing refers to the process of taking out a new private student loan to replace one or more existing student loans. You can refinance both federal student loans and private student loans, and there are specific pros and cons to each that we’ll talk about below.
The Benefits of Student Loan Refinancing
1. You can get a lower interest rate
The main reason to consider refinancing your student loans is the opportunity to lower your interest rate. A lower interest rate likely means lower monthly payments, a lower lifetime cost, and a quicker path to being debt-free.
Of course, refinancing doesn’t guarantee a lower interest rate. You still have to go through an approval process, during which the lender will evaluate your financial situation and offer you a loan, or not, based on the information they find. Some people go through this process only to get an offer that’s worse, or at least not much better, than the loans they already have.
The people who are most likely to get a better interest rate than what they have now are people who:
- Have high-interest rate student loans, and
- Have a credit score that’s significantly higher than when they took out their current loans.
If that’s the situation you’re in, you may benefit significantly from refinancing.
2. You may find a new private loan with better protections than your old private loans
For many years, most private student lenders offered very few protections to their borrowers. For the most part you had to make every payment on time and in full or you were in real trouble.
But that’s started to change. Newer lenders like SoFi and CommonBond have started offering greater protections, such as unemployment protection where your payments are forgiven during periods of unemployment, and disability protection where payments are forgiven during disability.
If you have older private student loans, refinancing may offer greater security. Every lender is different though, so you should carefully read the terms and conditions and compare each offer to see what kinds of protections are available to you.
The Downsides of Student Loan Refinancing
As tempting as it is to grab that lower interest rate, there are some big potential downsides to refinancing your student loans that need to be considered.
Here are four of the biggest.
1. You may lose federal student borrower protections
Refinancing your federal student loans is a big decision that needs to be made very carefully. You’re giving up a lot in the refinancing process, and in some cases you’re better off with the protections offered by federal student loans than you are with a lower interest rate.
Despite some improvements to borrower protections, private student loans still offer significantly fewer protections than federal student loans. Specifically:
- They are not eligible for income-driven repayment plans
- They do not offer the opportunity for forgiveness
- They do not offer deferment
- Many still do not offer things like unemployment or disability protection
2. Variable rates can be a tease
Some lenders will offer an incredibly low interest rate to entice you to refinance without emphasizing that the rate is variable and that it can change in the future.
If you have the money to pay your loans off quickly, taking advantage of a teaser rate like this can be a good idea. But if it will be a while before your loans are paid off, you should be careful about signing up for a variable interest rate loan that you may not be able to afford several years down the line.
3. Fees could eat away at your potential savings
Some lenders will charge application fees, origination fees, prepayment fees, and all kinds of other fees that can really add to the cost of the loan.
Just keep an eye out for fees when reviewing your refinance options. The more you have to pay, the less attractive that lower interest rate will be.
4. It could take you longer to pay off your loan
In some cases, refinancing will extend your loan repayment period. This may feel like a win given that it lowers your monthly payment, but it can end up costing you more over the long term, even with a lower interest rate.
When Student Loan Refinancing Makes Sense
So, when should you refinance your student loans and when should you take a different route?
In most cases, the answer is pretty simple if you’re talking about refinancing your private student loans. If you can get a better interest rate by refinancing, it will usually make sense to do it. You should always compare all the details of the loans, including the protections they offer and other fees involved. But given that lenders have generally improved their standards over the past few years, it will usually make sense to refinance your private student loans to get a better interest rate.
It’s a lot more complicated if you’re considering refinancing your federal student loans. You shouldn’t give up those protections lightly, especially if your budget is tight and any change in your situation might make it difficult to afford your payments.
Generally, refinancing your federal student loans makes the most sense if you meet all of the following four conditions:
- You have high-interest federal student loans
- You have excellent credit that will qualify you for the best refinancing deals
- You have a high, stable income that makes it unlikely you’ll run into trouble paying off the loan
- You don’t qualify for Public Service Loan Forgiveness
If that’s you, then refinancing can be a great move. Qualifying for a lower interest rate could help you pay your loans off sooner, and you have little risk of running into financial trouble.
If that’s not you, you may be better off sticking with your federal student loans, even at a higher interest rate.
Where to Find the Best Student Loan Refinancing Deals
It always makes sense to shop around before making any decision to refinance, just to see what offers are available and how they compare. You can look at interest rates, borrower protections, application fees, and other requirements, and even get pre-approval from certain companies.
MagnifyMoney has a comprehensive page that makes it easy to compare many of the leading lenders and get a sense of what’s available to you.
Here are our top three picks. Each of these lenders has earned an A+ MagnifyMoney transparency score for excellent transparency and ease of use.
- No origination fee or prepayment fee
- Fixed interest rates range from 3.25% to 7.13%, and variable interest rates range from 2.65% to 7.14%
- Flexible repayment terms
- Strong borrower protections relative to other private lenders
- No origination fee or prepayment fee
- Fixed interest rates range from 3.25% to 6.32%
- Customizable loan terms where you choose the interest rate/length of loan combination
- Unemployment protection
- No origination fee or prepayment fee
- Fixed interest rates range from 3.18% to 7.25%, and variable interest rates range from 2.60% to 7.10%
- No maximum loan amount and flexible loan terms
You can also check out your local credit unions, since they are member-owned and often offer loans with favorable terms and conditions.
Consolidation vs. Refinancing: Which One Is Right for You?
Student loan consolidation and student loan refinancing are very different processes with very different pros and cons. Each one can be the right choice, depending on your situation, and in some cases you may want to use both.
In the end, it’s all about your specific loans and the specific goals you’re trying to achieve. Use the information above to weigh pros and cons and make the right decision for yourself.
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