Many students and graduates take out multiple loans. Higher education isn’t cheap! If you’re in this category, you’ve probably considered combining all those loans into one—a common process known as either student loan consolidation or student loan refinancing.
Consolidation is the process of combining several federal student loans into one consolidation loan that retains all the benefits of federal loans: flexible repayment options if you lose your job or go back to school and forgiveness programs after years of service in certain qualifying fields.
Refinancing is the process of taking out a new private student loan to pay off and combine multiple private and/or federal loans. Refinancing may give you more options to reduce your monthly payment and interest rate, but refinancing federal loans can eliminate some of the benefits of federal loans.
Here, we’re going to talk mostly about when you might want to pursue federal student loan consolidation, but many of the rules apply to refinancing, too.
How does consolidation work? You take out a new loan, which then pays the balance on all your federal loans, even if they have different servicers (such as NelNet or Navient) — the companies to which you send your payments. You’re then responsible for paying off the new balance, known as a Direct Consolidation Loan, from a single lender. Loans combined into a Direct Consolidation Loan can’t be removed.
Fewer payments every month may sound like a no-brainer, but consolidation’s not best for everyone. Do you meet the conditions below? If so, you may want to consolidate.
When student loan consolidation makes sense
- You’re not in school currently, or you’re enrolled less than part-time.
- Your loans are not in default.
- You’re either making loan payments or in the loan is in a grace period.
- Your loans are in your name, not in your parents’ names or anyone else’s; you cannot consolidate your loans with your spouse’s loans.
Also important to know: you can’t consolidate private student loans with federal student loans. If you want to roll private and student loans together, you’ll need to explore refinancing your student loans. And depending on your lender, you may need to meet a minimum balance. (The Federal Loan Consolidation Program doesn’t require a minimum.)
You want to reduce your monthly payments
If short-term savings are your priority, consolidation is worth a look. You can lower your monthly payments and increase your repayment period.
Lower monthly amounts, though, mean you pay more over the loan’s life. Compare your current monthly payments to what the payments would be if you consolidated. Keep in mind: the longer your repayment period, the more interest you’ll pay.
If you want to consider refinancing, Money Under 30 partner Credible offers a free and easy way to see the loan rates and monthly payments you would qualify for from selected lenders — there’s no obligation or impact to your credit.
Your individual loans don’t offer flexible repayment options
Make sure you know the borrower benefits of your original loan before you consolidate. These include rebates, loan cancellation benefits, and interest rate discounts. Once the original loan disappears, you lose those benefits. PLUS loans, for instance, may have flexible repayment options unavailable after consolidation.
Loan consolidation may offer just the wiggle room you need, however, if your original loans are more rigid. Here are some common consolidation payback plans.
- Extended repayment, where you can have between 12 and 30 years to pay.
- Graduated repayment, where you begin payments at a low monthly amount that increases gradually every two years.
- Income-contingent repayment, where you calculate your income and outstanding debt, and your lender sets a repayment amount for you based on the total. As your income changes, this amount changes.
- Income-sensitive repayment, where your monthly payment is a percentage of your pretax monthly income.
You want a lower interest rate
But before you make the switch, here’s what you need to know. If you took out federal loans before 2013, you may have one of two types of interest rates: variable or fixed.
Variable interest rates can adjust each month, based on the interest rates available at the time. Initially, these rates may be lower than the interest on fixed-rate loans. If interest rates rise, however, your loan interest will rise with them. Same thing if interest rates fall. You’re at the mercy of the market. If you plan to pay off loans quickly when interest rates are low, a variable rate’s a good option.
In August 2013, the Bipartisan Student Loan Certainty Act of 2013 became law. Under this act, new federal loans have fixed interest rates determined each spring for the upcoming year. If you took out loans after the act was passed, you’ll have a fixed rate, not a variable one.
So what’s a fixed interest rate?
Fixed interest rates stay the same for the life of the loan. You’re more likely to have the same monthly payment each month. The initial interest rate (when you first sign on) may be higher.
Say you have pre-2013 federal loans with variable rates. Consolidation will allow you to switch from a variable rate to the new fixed rate. If you plan to repay loans over time, and you’d rather have a steady interest rate than a fluctuating one, a fixed rate may work best for you.
Will the fixed rate mean you pay less overall? Possibly. A variable rate can save you money if you have strong credit – and if interest rates don’t rise significantly. For long-term savings, it’s best to lock in a fixed rate when interest rates are low.
Want to crunch the numbers? The Federal Direct Consolidation Loans website offers an online calculator to compare interest rates.
Your credit score’s improved since getting the loan
Lenders love good credit. If you have private loans, they won’t be covered under the Bipartisan Student Loan Certainty Act, but you can still lower your interest rate through consolidation. Private student loans base interest rates on your credit score.
This means if you’ve had a jump in your credit rating, you may be in a good position to consolidate private loans. The higher score gets you lower interest.
You’ve just graduated and haven’t entered repayment
There’s a window of time, after you graduate but before your grace period ends, when you can still get the lower in-school interest rate. Many federal loans give you six months.
Act quickly, though. All consolidation paperwork must be processed and approved in those six months for the in-school rate. And once the consolidation goes through, you enter repayment – even if you’re still in the grace period. For graduates who want to get the ball rolling with repayment, consolidation may make sense.
You anticipate a change in income or expenses
Maybe you’re in a contract position with an end date, on track to a better-paying job, or planning to stay home with a child. If your life circumstances are changing, you may want to adapt your loan repayment plan to match.
For instance, if you’re on a ten-year repayment plan with your original loans, consolidation could get you an extension or offer the income-contingent payback plan. Consolidation also restarts the clock on deferments and forbearances, giving you extra time for each.
When should you avoid consolidation?
If your monthly payments are manageable, it may be tempting to consolidate out of convenience. But it may also be more trouble than it’s worth.
Once you near the end of your repayment – once you have a few thousand dollars or a couple more years to go – it’s usually not worth it to consolidate. You may lose any accrued benefits on your current loans. Additionally, if your interest rates are low already, keep them that way.
Do you want to pay loans off quickly (and do you have the resources)? Reconsider consolidation. If you choose to consolidate, you may be paying longer, and overall you may be paying more.
What to do before you consolidate
- Compare your current interest rate with the rate you’ll get on the consolidated loan.
- Compare your current monthly payment amount with what you’ll be expected to pay on the consolidated loan.
- Familiarize yourself with any borrower benefits in your original loans, and any benefits offered by the new lender after consolidation.
- Calculate the length of your repayment period after consolidation.
If you choose to consolidate, you can find more details in the complete version of the federal student loan consolidation application. And remember, if you have private student loans that you want to consolidate, you’ll need to look into student loan refinancing. The result is similar, but the loans are not subsidized by the U.S. Department of Education.