Considerations Before Consolidating Your Student Loans
Refinancing can oftentimes be confused with Consolidation, or vice versa, and sometimes refinancing companies use the term “consolidation” instead of “refinance” unfortunately - adding to the confusion.
A Direct Consolidation Loan allows you to consolidate (combine) multiple federal education loans into one federal loan, keeping everything within the federal system. Private refinancing companies cannot consolidate your loans within the federal system, they can only refinance them out of it. So when would you consider one over the other? What’s the difference?
Let’s first walk through to PROS to a Direct Consolidation:
If you currently have federal student loans that are with different loan servicers, consolidation can greatly simplify loan repayment by giving you a single loan with just 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.
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 get 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 ones repayment plan.
You’ll be able to switch any variable-rate loans you have to a fixed interest rate
I LOVE fixed interest rates :) No possibility of it ever increasing on you!
Because a Direct Consolidation loan is considered a brand new loan, it restarts the clock on deferments and forbearance for up to 3 years.
May be a safe-haven for someone with a financial hardship to extend not having a required monthly payment without a negative effect on credit.
On the other side of the table, there are some serious drawbacks to consolidation that should be considered before pulling the trigger:
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… If you have years under your belt going towards any kind of forgiveness timeline (PSLF or max-repayment periods), Consolidation restarts your clock at year 1. Sometimes it can still make sense for someone to Consolidate if they have some years banked - it just depends on their income trajectory and the rest of their plan.
Another common misconception is that you can Consolidate your loans to make you eligible 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 principal).
Another big consideration to make - Consolidation is a capitalization trigger where any accrued interest is added to your principal balance, and now interest going forward is charged off of that new principal balance. Continuously capitalizing accrued interest can make your loan very expense over time and make you feel like you’re spinning your wheels.
Because consolidation usually increases the period of time you have to repay your loans or reduces your required monthly payment, you might make more payments and pay more in interest than if you didn’t consolidate.
Remember our rule of thumb: If your balance is below your annual income, prioritize paying that off sooner rather than later to reduce your interest cost over time. Elongating your timeline in absence of leveraging the forgiveness opportunities with federal loans, may not be an efficient way to pay off your student loan debt.
Consolidation may also cause you to lose certain borrower benefits—such as 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.
Can no longer use a “snowball” pay-down approach.
Consolidation results in 1 interest rate based on the weighted average of all.
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.
No do-overs/not reversible once accepted.
Just like with anything, Consolidation can make sense for someone in the right circumstances. This pro/con outline should help guide you on what to consider before pulling the trigger.
Meagan Landress, CSLP®
Certified Student Loan Professional™
Financial Coach Meagan