According to researchers, 68 percent of college seniors today have student debt, which will take an average of 21 years to repay. While there are many majors and degrees that can lead to large annual incomes, there are others that make paying off a hefty loan quite difficult.
As many as twenty-eight percent of the students miss a payment and are in default within five years of entering repayment.
There are currently 44 million borrowers who owe a sum of $1.5 trillion collectively in student debt. The statistics indicate that many students are caught in a debt trap and need an extended credit line to stay afloat.
This is where student loan consolidation comes into the picture. You can have multiple student loans – both private and federal consolidated into one. You can simplify your monthly payments and even bring your interest rate down a notch.
However, you need to be careful as loan consolidation is a one-way street. If the decision turns out to be wrong, it can prove to be costly with no way to reverse the situation.
This guide will walk you through the basics of loan consolidation and refinancing. We will list out all the pros and cons of each consolidation option available. We will also talk about various considerations you need to keep in mind while choosing a particular loan consolidation process.
What is Student Loan Consolidation?
Student loan consolidation refers to combining multiple student debts into a single loan option. You only have to make a single payment to a loan provider instead of tracking multiple payments. It can come with an alternative repayment plan to make monthly payments more manageable.
Consolidation Loans are available for all Federal Student Loans except Direct PLUS loans taken out by parents. Loans including Stafford, Direct PLUS (Student), SLS, FISL, NSL, HEAL, Perkins, and Direct loans can be consolidated. Private education loans can be consolidated only through a private lender.
How is It Different from Student Loan Refinancing?
Refinancing is used in many realms of finance such as mortgages. It refers to switching over to a more advantageous loan option (with lower interest rates or better terms) and a more beneficial payment plan to pay off the existing loan.
Consolidating a loan is different from refinancing as it includes combining multiple loans into a single loan, sometimes with existing payment terms and interest rates.
Consolidating federal loans cannot be compared to refinancing as the weighted average interest rates of old loans is similar to the interest rate of new loan. However, private loans consolidation includes refinancing as the interest rate and terms of the new loan are almost always different from the existing old loans.
Types of Student Loan Consolidation
There are two types of student loan consolidations available – federal consolidation and private consolidation.
Federal consolidation cannot be used to combine private loans. These can only be used for federal student loan options.
Currently, there is only one consolidation loan option available – Direct Consolidation Loan. The new loan has a single fixed interest rate. This rate is the sum of weighted average of all interest rates of the old loans being consolidated.
This ensures that the new loan interest rate is influenced more by higher balance old loans than the ones with a lower balance. Comparative balance of each loan has a proportional impact on the interest rate.
You cannot expect to save on interest rate with weighted average. Your new consolidated loan will have the same interest burden as the previous existing loans. However, if your loan origination date is before 2006 with a variable interest rate, then you might benefit from consolidating your loans.
Who Can Consolidate Federal Loans?
Federal loans can be consolidated by borrowers who are in their repayment or grace period. Students who have graduated or left college can apply for a loan consolidation.
You should have a minimum of two federal student loans to become eligible for loan consolidation. You must have at least one FFEL Program loan or Direct Loan to be eligible for Direct Consolidation Loan.
Default loans can be consolidated when three consecutive monthly payments have been paid in full. It can also be consolidated if the borrower agrees to an income driven repayment plan to repay the consolidation loans.
- No credit check or cosigner
- Option to stop payments without defaulting with deferment and forbearance
- Zero origination fee and sundry costs
- Income driven repayment plan option for smaller monthly payments
- Cancelation of loan forgiveness
- No change in interest ratesvProgress towards loan forgiveness on existing federal loans is lost or reset with a new consolidated plan
- New repayment term could lead to increased interest payment and higher monthly payments
- Higher consequences in case of default as federal government can use tax refunds or garnish wages towards payment
- Opportunity loss by prioritizing high interest loans which could inflate the loan repayment amount
When to Consider this Consolidation Option?
Federal Loan Consolidation is for people who do not mind repaying the amount for a longer period of time (typically 25 years) to reduce their monthly premiums. Borrowers should consider a Direct Consolidation Loan in the following scenarios:
- Existing federal loans are not eligible for income-driven repayment plans
- Loan origination date is before 2006 with variable interest rate
- A single payment is sought for simplifying monthly payments
What is the Repayment Term Length?
Borrowers do not have the luxury to choose their repayment term length in Direct Consolidation Loans. The repayment term is calculated by the government on basis of total debt which includes private student loans as well.
Borrowers cannot lengthen the repayment period. However, they can shorten it by paying more than the minimum monthly payment at no extra charge.
This is a more flexible option than federal consolidation. A private lender writes a new loan to pay off the sum of all existing student loans.
Private consolidation loans can be used to consolidate both private and federal student loans. There are no limitations on the kind of loans you can consolidate under a private lender.
Unlike, federal consolidation you do not require a private student loan to be eligible for private consolidation. Private consolidation is a type of refinancing as the new loan terms and interest rates are different from the old existing loans.
Current credit rating and history of repayment plays a major role in determining the interest rate. Some lenders go as far as evaluating a borrower’s professional and financial circumstances while determining the interest rate.
Weighted average does not come into play when getting your loans consolidated with a private lender. The new interest rate can be variable or fixed and can be higher or lower than the weighted average of existing interest rates.
Fixed interest rates do not change with market trends for the duration of your loan term. Variable interest rates can change with market conditions. This is a major benefit of private consolidation over federal consolidation. It can bring down your monthly premium by lowering the interest rate.
Who Can Consolidate Private Loans?
Both private and federal loans can be consolidated under this option. Credit history and repayment capabilities play a major role in having your loans consolidated from a private lender. You need a clean credit history and a FICO credit score above 670.
However, borrowers with a poor credit history or score may also qualify if they can bring a cosigner on board. The cosigner should have an excellent credit history. Some lenders may also release an existing cosigner if the borrower’s credit score has become good and has steady income.
Other factors such as borrower’s debt to income ratio and employment stability are also factored in while determining loan consolidation.
Some lenders might set minimum annual income requirements as the deciding factors. Many lenders offer consolidation options to those students who have completed a specific type of degree.
There are some major advantages to private consolidation loans that are not offered by federal consolidation:
- Some lenders might release the cosigner of existing loans while consolidating them into a new loan.
- You can accrue a lower interest rate decreasing your monthly premium payments through this option as there is no weighted average.
- You can have the loan duration extended past the duration of old loans. However, this might result in increasing the overall cost even if it brings down the monthly premium amount.
You must consider these significant drawbacks especially when planning to consolidate federal loans with private loans:
- Multiple eligibility requirements including clean credit history, good FICO score, degree completion, annual income threshold and a cosigner
- Some lenders might tack an additional origination fee in the range of 1% – 2% to the loan amount resulting in additional interest
- Zero benefits for borrowers facing financial hardships
- No loan forgiveness or cancelation option
- Private loans do not offer fringe benefits such as interest reduction
- Inconsistent evaluation among multiple lending breadths can make the process confusing
When to Consider this Consolidation Option?
There are two approaches to private consolidation. You can either consolidate private loans or you can consolidate both private and federal loans together.
You should consider having your private loans consolidated when:
- You have a better credit history which can significantly lower the interest rate
- If the new private lender is offering multiple attractive fringe benefits like forbearance
- your current lender becomes a hassle
- You want to release a cosigner because your credit history has improved
- Variable rates are increasing and you want the long-term security of fixed rates
Consolidating private and federal student loans with a private lender is a stellar option when:
- You have an excellent credit score and are confident in your earning capabilities
- You no longer want financial benefits with high interest rates that come with federal loans
- Your federal loan is a graduate loan with high interests. Private interest rates are more competitive in graduate loans
What is the Repayment Term Length?
Repayment term length is shorter with private lenders (typically 5 to 20 years). However, some private lenders might offer a long repayment term with a higher interest rate.
A shorter repayment term has a single most glaring benefit of lowering the interest amount payable. Borrowers are forced to pay a high monthly premium which brings down the overall interest amount paid. It is always wise to choose the shortest manageable repayment period.
Federal Consolidation vs. Private Consolidation
Federal and private consolidations have their individual pros and cons. Each student debt scenario is unique. There are a number of factors that go into choosing the right consolidation strategy. It is important that you consider the following factors while making your decision.
Keep Federal Loans Separate
Federal loans come with many benefits that come handy when your financial situation is bad. You should note that once you consolidate your loans, there is no going back.
You lose out on all fringe benefits and fixed interest rates when you consolidate federal loans with private loans. Therefore, it may be better to have your federal loans consolidated separately from your private loans.
Consolidate High Interest Federal Loans with Private Loans
Private lenders don’t even come close to matching the low interest rates offered by the government on undergraduate student loans. However, graduate loans are a whole different story.
Consolidating graduate federal loans with private loans can save you tons of money in terms of interest. However, you need to make sure that your credit rating is suitable enough to get you a low interest consolidation option.
What is the Process?
You need to be absolutely sure that you want to consolidate your loan before you jump into anything. You might lose your current progress towards loan forgiveness in case of federal loans and other loan benefits with this step.
Federal Loan Consolidation
Visit the website studentloans.gov and start your loan consolidation application. Choose the loans you want to consolidate and select a loan service provider. You can delay loan consolidation to enjoy grace period on the loans that are currently not up for repayment.
Choose a repayment plan and submit the application for processing. You will have to continue making payments until your application is approved.
Private Loan Consolidation
This is the same as taking up a loan or getting a loan refinanced. However, choosing the right lender is critical as there is more to loan consolidation than just interest rates.
The first step is to screen for your eligibility. This will give you a list of lenders who are willing to provide you a loan. Next, filter the lenders on basis of their interest rates.
Getting rate quotes can affect your credit if the lender does not perform a soft credit check. Choose a private lender on the basis of the costs, loan terms and conditions, repayment options and fringe benefits, if any.