What to Consider Before Consolidating Your Student Loans

October 10, 2019

We recently dove into the topic of refinancing your student loan. That can be a great way to reduce your monthly payments, lower your interest rate, or change your loan terms IF it makes sense for your specific situation. But there are always lots of factors to consider when student loans are being discussed.

Refinancing is the act of taking your federal student loans and/or your existing private student loans and replacing them with a new private loan. But refinancing and consolidating are two entirely different processes. And deciding whether or not refinancing or consolidating your loans is a good move comes down to your specific loan terms. That’s why this advice on what to consider before you consolidate your student loans is so important.

The differences between refinancing and consolidating your student loan

Refinancing is oftentimes confused with consolidation. The terms are often used interchangeably (although they shouldn’t be). Sometimes student loan refinancing companies use the term “consolidation” instead of “refinance” which only adds to the confusion. A Direct Consolidation Loan allows you to consolidate (combine) multiple federal education loans into one federal loan. That keeps everything within the federal system – which has some borrower benefits. Private refinancing companies cannot consolidate your loans within the federal system, they can only refinance them out of it. So when should you consider one over the other? And what’s the difference?

The PROS of considering direct consolidation 

  • If you currently have federal student loans that are with different loan servicers, consolidation can simplify loan repayment. That’s because consolidating your loans gives you a single loan with one monthly bill.
    • It can be tough to track multiple payment amounts on different due-dates to different companies. Consolidation allows you to pick your preferred servicer as well. 
    • Doing this right out of the gate post-graduation will help you get organized on the front end of your repayment. If you consolidate early you won’t need to take into account all the “cons” listed later on in this article.
  • If you consolidate loans other than Direct Loans, such as FFEL, Perkins, & HRSA loans, it may give you access to additional income-driven repayment plan options and Public Service Loan Forgiveness (since only Direct loans qualify for PSLF). This could also reduce your monthly payment.
    • This is a KEY reason why consolidation can make sense for someone. If you have FFEL loans and are working towards PSLF, those loans will NOT be forgiven. Only Direct loans qualify for loan forgiveness. 
    • Another key reason to consolidate would be to make specific loans qualify for an income-driven repayment plan. Direct loans are eligible to be calculated under the ICR, REPAYE, and PAYE plans. If you’ve got some loans in your loan list that don’t qualify, those will be calculated differently under IBR (15% discretionary income), making your payment slightly higher.
  • Parent PLUS loans can qualify for ICR (Income-Contingent Repayment). 
    • Parent PLUS loans are their own beast…they only have access to the amortized repayment options within the federal system or ICR if consolidated (20% discretionary income). Even with the high % calculation, this option could make sense for some people.
  • You’ll be able to switch any variable-rate loans you have to a fixed interest rate
    • Fixed interest rates are great! It’s nice to know that your interest rate will never rise no matter what happens with interest rates in the future. 
  • Direct consolidation restarts the clock on deferments and forbearance for up to 3 years.
    • This may be a safe-haven for someone going through financial hardship. It can allow certain borrowers to extend not having a required monthly payment without a negative effect on their credit. 

There are also some serious potential drawbacks to consolidating your student loans that should be considered before pulling the trigger.

The CONS of considering direct consolidation

  • If you’re paying your current loans under an income-driven repayment plan, or if you’ve made qualifying payments toward Loan Forgiveness, consolidating your current loans will cause you to lose credit for any payments made toward an income-driven plan’s maximum repayment period or Public Service Loan Forgiveness (PSLF).
    • This is one of the main reasons why you would NOT want to consolidate your loans. If you have a number of years under your belt going towards any kind of forgiveness timeline (PSLF or max-repayment periods), consolidating restarts the clock back to year one. It can still make sense for someone to consolidate if they have some years banked. But it’s important to consider income trajectory and the rest of the repayment plan. 
    • Another common misconception is that you can consolidate your loans to gain eligibility for PAYE if you had outstanding loans prior to 10/1/2007 – this is false. Your original loan date does not change. 
  • Interest is capitalized (accrued interest is added to the principal).
    • Something else to consider is that consolidation is a capitalization trigger. Any accrued interest is added to your principal balance. Going forward, interest is charged off of that new principal balance. Continuously capitalizing on accrued interest can make your loan very expensive over time. It can also make you feel like you are spinning your wheels. 
  • Consolidation usually increases the period of time it will take you to repay your loans or reduces your required monthly payment. You might make more payments and pay more in interest than if you opted not to consolidate.
    • Remember this rule of thumb: If your balance is less than your annual income, prioritize paying that debt off more quickly to reduce your interest cost over time. Lengthening your payoff timeline without leveraging federal loan forgiveness opportunities is likely not an efficient way to pay off your student loan debt.
  • Consolidation may also cause you to miss out on certain borrower perks. You might lose interest subsidies or some loan cancellation benefits (notably Perkins Loans)—that are associated with your current loans.
    • Perkins loans have certain forgiveness opportunities (outside of PSLF and max-repayment periods). Consolidating these and changing their ‘loan code’ eliminates those same opportunities. 
  • Consolidating means you can no longer use a “snowball” pay-down approach.
    • Consolidation results in a single interest rate based on the weighted average of all your current interest rates.
    • With that said, there is no real interest rate benefit to consolidation. The new fixed interest rate will be calculated by taking the average of all consolidated interest rates, rounded up to the nearest 1/8th of a percent.
  • There are no do-overs when it comes to consolidation. It’s not reversible once accepted.

Where to go to start consolidating your student loans

Consolidation can make sense for someone given the right circumstances. These tips of what you need to consider before consolidating your student loans should help guide you before you pull the trigger. If consolidating your student loans makes sense for you, you can complete your free online consolidation application at www.studentloans.gov.

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