A question I get asked very frequently is: "Should I consolidate my federal student loans into a private consolidation loan?" And my answer is... it depends, but USUALLY no.
Reason being... private student loan debt & federal student loan debt is not an apples-to-apples comparison.
I always recommend looking outside just the interest rate when considering private refinancing. When you consolidate your loans from federal to private, you loose a lot of federal benefits & protections, and you can’t reverse it once it’s done.
If your student loan debt balance is lower than your annual income, you should likely prioritize paying your loans down quickly to minimizing the interest that you're going to be charged over time, HOWEVER consider the following before committing to a private consolidation:
First thing to consider here is interest is not charged the same: On the private side, your interest capitalizes (aka: compounds). Capitalization is the addition of unpaid interest to the principal balance of your loan. This means the debt can grow quicker and more substantially over time, especially if you only pay the minimum which usually doesn't cover the actual interest charge per month. The math for compound interest is simple: Principal x interest = your new balance, which interest is then charged off of, usually at a daily rate!
On the flip-side, with federal loans on income-based plans, interest does NOT capitalize. Interest is only charged on the initial principal amount, not principal + accumulated interest - that is a HUGE deal for those with high debt-to-income ratios.
Another perk to federal student loans is the interest subsidies or discounts/credits on how the interest is charged to you - this depends on your plan but generally interest can be waived or cut in half for time periods on certain loans.
Other things to consider would be the flexibility of fed loans and their repayment terms.
- Private loans do NOT have income based plans and are not lenient if you loose your job or cant afford the payments anymore. Think through if you will be able to commit to that private payment for the length of the term. There is a lot of benefit to having access to the federal income-based repayment plans to keep your payments proportionate with your income year over year.
- Fed loans have options to defer or go into forbearance if there is a financial hardship, disability, illness/heath issues, etc. - Private loans do not have these options. At all. Private debt payments are still due even if you die, and they’ll be paid from your estate before any $ goes to your family...
- Confirm whether or not these private offers are variable or fixed interest rates (or if there are triggers such as being late on a payment to loose the ‘fixed’ benefit) and if so, when can it change on you? That low advertised interest rate may just be an introductory rate and could increase on you in the future.
Times when it could make sense to do a private refinance is:
1. If you have a balance much MUCH lower than your annual income
2. You want the loans paid of ASAP
AND you have STELLAR credit - a lot of times the advertised, super-low interest rate for private consolidation loans is very difficult to get approved for. The average credit score needed to be approved in 2018 was a FICO score of 764... so if you don't have a score in that range, be prepared get declined altogether.
Speak to a Certified Student Loan Professional™ to see if a Private Consolidation is right for your student loan repayment plan.
Meagan Landress, CSLP®
Certified Student Loan Professional™
Financial Coach Meagan