If you’re feeling the squeeze of student loan payments on an already tight budget, then you’re not alone. Borrowers may turn to student loan forgiveness or loan cancellation programs only to learn that they are ineligible.
The next step is often student loan consolidation or student loan refinancing to lower monthly payments.
When it comes to the student loan consolidation vs. student loan refinancing debate, both are options that change the original structure of your loans and may improve your cash flow. However, combining multiple loans into one loan with a single lender is where the commonality ends. Each option has benefits and reasons to pause since making the wrong choice for your situation could cost you in unexpected fees and increased principal.
What Is Student Loan Consolidation?
Consolidation one of the more popular student loan options that involves a new lender paying off multiple existing loans and creating a new loan resulting in a single monthly payment. The old loans no longer exist. Federal Student Loan Consolidation is only available for Federal Student Loans through the US Department of Education. This means that you cannot consolidate any private loans with the new Federal loan.
Federal Student Loan Consolidation is free, so there is no need to pay a company a fee to consolidate your loans. You can consolidate your loans yourself in under 30 minutes by logging into studentloans.gov or contact your loan servicer for assistance. You can also talk to a real live person at the Dept of Education by calling 1-800-557-7394.
Can Your Student Loans Be Consolidated?
The following types of federal student loans can be consolidated under the Federal Direct Consolidation Loan program:
- Subsidized Federal Stafford Loans
- Unsubsidized Federal Stafford Loans
- PLUS loans from the Federal Family Education Loan (FFEL) Program
- Supplemental Loans for Students
- Federal Perkins Loans
- Nursing Student Loans
- Nurse Faculty Loans
- Health Education Assistance Loans
- Health Professions Student Loans
- Loans for Disadvantaged Students
- Direct Subsidized Loans
- Direct Unsubsidized Loans
- Direct PLUS Loans
- FFEL Consolidation Loans and Direct Consolidation Loans (only under certain conditions)
Unfortunately, private loans are ineligible for consolidation under this program. The good news is that any private loan debt that you carry can benefit you when applying for your new Direct Consolidation Loan. The repayment term may be increased based on the number of private loans you have at the time of application.
Benefits of Student Loan Consolidation
- Direct Consolidation Loans are eligible for the following repayment plans:
- Standard Repayment Plan – Fixed rate payments over 10 – 30 years
- Graduated Repayment Plan – This plan begins with lower than normal payments which increase approximately every two years to ensure the loan is paid off in 10-30 years.
- Extended Payment Plan – Payments begin as fixed amounts but may increase at certain intervals to ensure the loan is paid within 25 years.
- The new consolidated loan may allow you to qualify for the Income-Based Repayment Plan (IBR), Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), or Income Contingent Repayment Plan (ICR) which are income-based repayment plans with unique benefits. Each of these options requires an annual review of your financial situation to determine the required monthly payment. Any outstanding balance may be forgiven if the loan is not paid in 20-25 years depending on the plan. The type of loans which make up the consolidation loan will determine your eligible repayment plan.
- Eligible borrowers can tap the Public Service Loan Forgiveness (PSLF) Program which provides student loan forgiveness options after making 120 qualifying monthly payments.
- You can switch your variable interest rate loans to a single loan with a fixed rate.
- Take up to 30 years to repay the consolidated loan which usually means lower monthly payments.
- There is one bill and one payment to make instead of several for each loan which also means less paperwork.
- Borrowers can pre-pay the loan in full without penalty.
- Servicer troubles? A new consolidated loan may place you with a new servicer. Our readers ranked Great Lakes as the top servicer for federal student loans.
Drawbacks of Student Loan Consolidation
- Interest capitalizes resulting in an increased loan balance and ultimately a loan repayment amount larger than when you originated the loan.
- You lose any borrower benefits tied to your original loan (low-interest rate, specific loan cancellation options, etc…)
- A consolidation loan contains no interest rate limits. According to Federal Student Aid, the fixed rate is based on the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest one-eighth of 1%. Thus, there are no interest savings when consolidating federal student loans.
- You lose any credit towards loan forgiveness already accrued under your old loans. A Federal Direct Consolidation loan is a brand new loan, which wipes away any previous credit towards income-based repayment programs or PSLF.
Student Loan Consolidation Scams
The unfortunate truth is that student loan consolidation scams abound. A common scam is for the nefarious company to make demands for money while leaving you in the dark on the actual loan consolidation process.
For example, they may insist that you pay them $200.00 a month for six months while they “process” your loan consolidation. They fail to disclose that these are payments to the company and not the loan itself despite the assurance that they would pay the loan on your behalf during the processing period. Once you’ve handed over your money, you may find that your loan was never consolidated but only put in deferment or forbearance, and you are out the $1,200.00.
Be on the lookout since some of these scammers also use program phrasing to mislead borrowers. For example, the “Obama Student Loan Forgiveness Program” or “Trump Student Loan Forgiveness Program” does not exist, but the Pay As You Earn (PAYE) program does. Unscrupulous companies try to fool consumers into thinking that they are one in the same.
Scam red flags:
- The company requires a power of attorney over your loans.
- Payment is required before the student loan consolidation is complete.
- No education regarding the process is provided. You are left in the dark as far as your rights and responsibilities during the process.
Are You Eligible For Student Loan Consolidation?
Have you graduated, withdrawn from school or dropped below half-time enrollment? You may be eligible for consolidation as long as you have at least one FFEL Program Loan or Direct Program Loan in repayment status. Even if you currently have a Federal Direct Consolidation Loan, you may be able to add additional federal education loans to the consolidation by completing the Request To Add Loans form.
This “add loans” option in the consolidation can be a lifesaver for borrowers who want all their debt to be eligible for forgiveness programs.
How Do You Apply For A Student Loan Consolidation?
A borrower can complete the free Federal Direct Consolidation Loan Application and Promissory Note online at StudentLoans.gov or by completing a paper application. The process is usually completed in less than 30 minutes. Gather the following information before you begin the application to expedite the process:
- Federal Student Aid ID
- Personal Information
- Permanent Address
- Email Address
- Telephone Number
- Mobile Phone Number
- Best Time to Teach You
- Financial Information
- Have all of your current student loan account information in front of you
- Determine your choice of repayment plan (REPAYE, PAYE, IBR, or ICR)
- Adjusted Gross Income – This will be verified using an Internal Revenue Service data retrieval tool to document your income electronically. If your most recent tax return does not reflect your current income level, you will be able to provide current income information to your loan servicer for processing. If you do not have an income, you will be able to self-certify this on the online application.
- Contact information for references
If questions arise during the process, borrowers can contact the Student Loan Support Center at 1-800-557-7394.
When It Might Not Be a Good Idea to Consolidate
- You’ve paid years towards an income-based repayment plan on FFEL. Remember, a consolidation loan creates a brand new loan so traction gained from repayment is lost.
- You already have credit towards loan forgiveness on Direct Loans. For example, if a forgiveness program requires five years of eligible employment and you are three years in, then a consolidation loan may not be your best option.
Student Loan Consolidation vs. Student Loan Refinancing: What Does It Mean To Refinance A Student Loan
Similar to consolidation, student loan refinancing is the act of a new lender paying off multiple existing loans and creating a new loan which results in a single monthly payment. Lenders that offer refinancing programs pay off your FFEL, Direct, and private loans and originate a new loan.
The newly refinanced loan may result in a lower payment and interest rate in addition to overall better terms. Private loan lenders offer refinancing options, not the federal government. Therefore, federal student loan benefits and rules will not apply. The new promissory note will dictate your new rights and responsibilities associated with the new loan.
Why Refinance Your Student Loans?
- Lower interest rates could save you thousands of dollars or more. Some private loan lenders have interest rates starting at 1.95%. Use a student loan calculator to estimate your potential savings.
- You want to dump your lousy loan servicer
- Potential to get rid of debt quickly
- You want to pick up a cash back refinancing bonus
- You want to release a co-signer from your prior loan
- You want a lender who offers professional perks, e.g., Laurel Road provides unique refinancing options to medical professionals
Student Loan Refinance Eligibility
On the surface, it seems like refinancing might be the better choice to make your student loan payment more manageable, but there is a stark difference in the eligibility requirements for student loan consolidation and student loan refinancing. Unlike the Direct Loan Consolidation program, student loan refinancing through a private lender looks to a borrower’s credit and income to determine loan eligibility. Some common eligibility considerations include:
- A 650 credit score or above
- Reasonable monthly housing and car payments relative to income
- Low or no credit card debt
- Often requires the completion of the education program, i.e., graduated
- Stable income
When is Student Loan Refinancing a Bad Idea?
If you are seeking student loan forgiveness, student loan refinancing is a very bad idea. Once you decide to refinance, you have to pay the whole amount back. This could be very much in your favor, as a private practice physician making $250,000 will not be receiving any forgiveness on her $200,000 of med school debt.
However, the chiropractor with $250,000 of loans earning $60,000 per year will not be able to make the refinancing math work out. He should consider using the PAYE 20-year forgiveness option instead.
If you are in the public sector or will owe more than two times your household income for most of your career, student loan refinancing will likely not be a good idea.
If you will owe less than two times your income shortly and you work in the private sector, student loan refinancing can be a boon to your financial life.
How Student Loan Consolidation and Student Loan Refinancing are Similar
Each option takes multiple loans and creates one new loan
- Both are sold as the cure-all to student loans since both have the ability to lower your monthly payment
You need a strategy, not just a one-liner. There is no substitute for educating yourself beyond the promotional ads you see plastered all over the internet.
Other Considerations to Consider when Choosing Between Student Loan Consolidation vs. Student Loan Refinancing
- You cannot undo a loan consolidation or loan refinancing.
- If Federal loans are included in the refinancing package, you will lose all benefits associated with the Federal loans. Some private lenders offset these losses by offering their version of unemployment protection and other perks. However, none of these private lender protections are as good.
- Most student loan refinance lenders offer competitive interest rates, so determine what else is important to you. Identify the lender’s borrower benefits that are meaningful versus ones that have no real value to you or your financial situation. For example, some, but not all, private loan lenders offer borrower protections in the form of deferment, forbearance or flexible repayment plans in the case of unexpected financial hardship. CommonBond, a private loan lender, goes a step further and highlights the social impact you would have by refinancing with their company. For every refinancing, CommonBond will fund a child’s education in a foreign country.
- If your experience with your prior servicer left you frustrated, be sure to do a bit of background research on your potential new servicer to avoid another bad experience.
- Some private loan lenders have residency restrictions. Borrowers may need to reside in a particular state as a condition of loan eligibility.
Student Loan Consolidation and Student Loan Refinancing Can Help if You’ve Got a Plan
Student loan consolidation and student loan refinancing are both viable options that simplify the tracking of multiple student loans. Since each person’s financial situation is different, it is essential to consider which benefits will have the most significant impact on your current and projected financial future.
Regardless of which option you choose, continue to make payments on your existing loans during the consolidation or refinancing process. Failure to comply with the original terms of your current loans during this time may result in late fees or other penalties.