Should You Consolidate Your Student Loans?

With regard to student loans, many people use the terms refinance and consolidate interchangeably. They are not the same thing.

Refinancing involves taking out a new private loan to replace one or more existing student loans (federal or private). Most individuals refinance to obtain a lower interest rate loan.

Consolidating a student loan is a process through the Federal Direct Loan Consolidation Program. This program allows you to combine multiple federal education loans into a single loan, at no cost to you. Once your loans are combined into a Direct Consolidation Loan, the action cannot be undone. The loans that were consolidated are paid off and no longer exist.

Consolidating can be beneficial for some, but it’s not an appropriate solution for every borrower. In this article, I’ll discuss several important factors to consider before consolidating your loans.

Reasons to Consolidate Your Student Loans

There are three primary reasons to consider consolidation, with number one being the most common:

1) Qualify for income-driven repayment plans

I recently wrote a post about Federal Loan Repayment Plans. These repayment plans can be incredibly helpful for people who have a lot of student loan debt and modest income. These plans can decrease your required monthly payment, and many offer loan forgiveness after making payments for 20-25 years.

To access these plans, borrowers must hold eligible federal student loans. Not all loans are eligible.

Before 2010, federal student loans were disbursed in two different ways. You could obtain a loan directly from the federal government, or obtain a FFEL loan from a private company.

Only direct federal loans qualify for the best income-driven repayment plans, while FFEL loans are not eligible.

The good news is that you can turn one or more FFEL loans into a direct loan through consolidation.

2) Lock your interest rate

Many older federal loans have a variable interest rate. Since 2006, all loans have been fixed rate.

If you have a variable rate loan, you can consolidate and the new loan will have a fixed rate.

This is advantageous if you can lock in a low-interest rate. It is also nice to know your exact monthly payment for the life of the loan (the monthly payment on a variable interest loan fluctuates with interest rate changes).

3) Escape default status 

If you are currently in default on your loan payments, consolidation is one way out.

You can only do this once in your lifetime, so make sure you are ready to begin making payments on the new consolidation loan.

Important Notes about Consolidating

Before you consolidate your loans, keep the following in mind:

The interest rate on your loans

Consolidating your loan(s) will not impact the effective interest rate on your debt.

The interest rate on a consolidation loan is the weighted average of all the loans you choose to consolidate. The interest rate is exactly the same before and after consolidation, period.

Let’s say that you have two federal student loans, each with a $15,000 balance. One carries an 8% interest rate and the other carries a 6% interest rate. If you consolidate them, you will end up with one $30,000 loan at a 7% interest rate.

Because of this, consolidation can be a bad idea for many borrowers.

As I showed previously, the most efficient way to eliminate debt is by paying the highest interest rate debt first. In this example, it would be more efficient to keep these loans separate while throwing all of your available cash flow at the 8% loan.

If you consolidate, you lose the ability to prioritize the higher interest debt. Unless you are receiving other important benefits (like those described above), it might be better to avoid consolidation in situations like this.

Loan forgiveness can be lost

If you have already made progress toward any loan forgiveness, you should think twice about consolidating. Progress toward loan forgiveness is typically forfeited during consolidation.

Extending the length of your loans

When you consolidate, you are resetting the clock on your repayment schedule. Monthly payments might be lower, but you could be making payments for 30 more years.

Be careful with Parent PLUS loans

Parent PLUS loans do not qualify for most income-driven repayment plans, even after consolidation.

Do not mix Parent PLUS loans with other federal loans in the consolidation process. Doing so will make the entire consolidated loan ineligible for income-driven repayment plans.

How to Consolidate Your Loans

The consolidation process is relatively straightforward, and you are able to select your chosen repayment plan in the same application:

  1. Decide which federal loans you want to consolidate
  2. Decide which repayment plan you prefer for your new loan
  3. Visit StudentLoans.gov
  4. Create or Login with your FSA ID
  5. Complete the electronic application

Feel free to leave a comment below if you have additional feedback or questions.

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