Is Student Loan Consolidation Right for Me?

If you are struggling to afford your monthly student loan payments, if you are overwhelmed trying to keep track of your outstanding student loans with different loan servicers, or if you are trying to protect your credit score from your outstanding crippling student loan debt, one option to consider is student loan consolidation

Like consolidating credit card debt, medical debt, or even back taxes, student loan debt consolidation allows you to simplify your student loan repayments by giving you one single loan with just one monthly bill with a fixed interest rate. 

There are two ways to consolidate student loan debt:

  • A Federal Debt Consolidation Loan. This type of student loan debt consolidation through the Department of Education is only available for federal student loans and does not apply to PLUS loans to parents or private student loan debt.
  • Private Debt Consolidation Loan or Student Loan Refinancing. For those with private student loan debt or good credit scores, one option is to consider a private debt consolidation loan via a private lender, which can be used to consolidate both private and federal student loan debt.

When it comes to a Federal Debt Consolidation Loan, it doesn’t matter if you have subsidized or unsubsidized federal loans, you just can’t include private student loans in this type of consolidation loan.

Additionally, if you are considering applying for a Federal Direct Consolidation Loan, it’s important to note that this type of student loan consolidation is not likely to reduce your interest rate. That’s because the goal of this kind of debt consolidation loan is to ensure as many of your student loans as possible are eligible for federal repayment plans and loan forgiveness rather than reducing your interest rate. 

Consolidating your student loans with a Federal Direct Consolidation Loan may allow you to access income-driven repayment plans, which will lower your monthly payment. You may also gain access to forgiveness options such as the Public Service Loan Forgiveness program. 

Another reason federal student loan consolidation doesn’t necessarily lower interest rates is because federal student loan interest rates work differently than other types of debt. Student loans often have variable interest rates, but if you consolidate your federal student loans with a Direct Consolidation Loan, you’ll have a fixed interest rate. The fixed interest rate is determined by the weighted average of the interest rates on the loans that are being consolidated, which is then rounded up to the nearest one-eighth of one percent.

For example, if the weighted average of your previous student loan interest rates was 6.15 percent, your new interest rate would be 6.25 percent. 

While consolidating credit card debt, for example, may offer you the chance to lower or eliminate interest payments, interest rate reduction is not necessarily the primary goal when it comes to federal student loans. In other words, consolidating federal student loans won’t necessarily result in lower interest rates, but lower interest rates isn’t necessarily the goal when it comes to federal student loan debt consolidation; it’s reducing your monthly payment to allow you to repay your student loan faster and without defaulting.

If lowering interest rates on your student loans is important to you, know there is a way to lower interest rates on student loans, but it usually requires any federal student loan debt to be converted to a private student loan debt, which makes the borrower ineligible for certain programs such as student loan forgiveness. 

How Do I Consolidate Student Loan Debt?

If you have federal student loans, you can apply to consolidate your loans into a Direct Consolidation Loan from the Department of Education. There is no application fee to apply for the loan. If you are approved, all your eligible federal loans will be consolidated into a single monthly payment. Once your Direct Consolidation Loan is approved, you’ll want to enroll in a federal repayment plan. Enrolling in a federal repayment plan allows you to create a repayment schedule that works for your budget and allows you to choose hardship-based repayment plans such as Income-Based Repayment. 

There are four different types of Income-driven repayment plans with monthly payments that are affordable based on your income and family size, meaning your payment can go up and down as your income and family size changes. Monthly payments can be as low as $0, depending on your circumstances.

Under all four repayment plans, any remaining loan balance is forgiven if your federal student loans aren’t fully repaid at the end of the repayment period. 

  • Revised Pay As You Earn Repayment Plan (REPAYE Plan)

Under this plan you generally pay about 10 percent of your discretionary income toward student loan debt. For undergraduate loans, you’ll make payments for at least 20 years before the remaining loan balance is forgiven. For graduate or professional study loans, any amount not paid off after 25 years is forgiven.

  • Pay As You Earn Repayment Plan (PAYE Plan)

Under this plan you generally pay about 10 percent of your discretionary income toward your student loan debt, but your monthly payment never exceeds what it would be under the 10-year standard repayment plan amount. If you have any remaining balance after 20 years, it is forgiven regardless if the loans were for undergraduate or graduate studies.

  • Income-Based Repayment Plan (IBR Plan)

If you took out student loans before July 1, 2014, you’ll generally pay 15 percent of your income toward your student loan debt, but never more than you would pay per month under the 10-year standard repayment plan. Any amount not paid off after 25 years is forgiven.

If you took out student loans on or after July 1, 2014, you’ll generally pay 10 percent of your income toward your student loan debt, but never more than you would pay per month under the 10-year standard repayment plan. Any amount not paid off after 20 years is forgiven.

  • Income-Contingent Repayment Plan (ICR Plan)

Under this plan you’ll pay whichever is less: 20 percent of your discretionary income or what you would pay on a fixed 12-year repayment plan, adjusted based on your income. Any amount not paid off after 25 years is forgiven. 

You can learn more about which types of loans qualify under the different income-driven repayment plans here

Make sure before you commit to a specific income-driven repayment plan you use the Loan Simulator to compare estimated monthly payment amounts under the different plans. This tool is helpful because you may find one income-driven repayment plan offers a lower monthly payment based on your individual circumstances compared to the others. 

If you have private student loan debt, you won’t be eligible for the Federal Direct Consolidation Loan, but you can apply for a private student debt consolidation loan, also known as student loan refinancing. 

Consolidating private student loan debt works similarly to a credit card debt consolidation loan in that you apply for a consolidation loan through a private lender and will qualify based on your credit score. Once approved, you’ll choose a repayment term with monthly payments that you can afford based on your budget. With this type of consolidation loan you’ll be charged interest based on your credit score.

There are generally two types of student loan refinancing plans:

  • Longer Term Repayment Plans will reduce your monthly payment to something you can afford, but because it will take longer to pay off the student loan debt you’ll end up paying more due to interest payments.
  • Shorter Term Repayment Plans have higher monthly payments but because you’ll pay off your student loans faster than you would on a longer-term plan, you end up saving money in interest charges.

Once your private student loan debt consolidation loan is approved, the lender will disburse the funds to pay off the existing student loans you consolidated, allowing you to focus your one monthly payment on the new consolidated student loan.

Benefits of Private Student Loan Consolidation

Although consolidating student loan debt is similar to consolidating other types of debt, such as credit card debt, you generally cannot consolidate student loan debt with other types of personal debt. And while private student loan consolidation doesn’t allow you access to loan forgiveness programs such as the income-driven repayment plans, private lenders generally offer better interest rates and terms compared to the federal program. 

For example, under the federal direct consolidation loan, it doesn’t matter if you have good or bad credit, your interest rate is the weighted average of the fixed interest rates on your existing loans. But with a private lender, your excellent credit score may make you eligible for lower interest rates.

Another factor to consider is the loan term length. Federal direct consolidation loan terms are dependent on the repayment plan you qualify for, meaning your repayment plan can range from 10 years up to 30 years. With a private lender you can choose your term length. 

Private student loan consolidation programs also tend to have better customer service than the federal consolidation programs. Under the federal direct consolidation loan program, you are assigned a federal student loan servicer and there’s little you can do to change servicers. While private loan servicers can have customer service issues too, the Consumer Financial Protection Bureau reported that more than half, 54 percent, of student loan complaints were related to federal loan servicers. With private loan servicers, you can research and choose a company based on their reviews.

Another perk of private student loan consolidation? You don’t have to worry about annual recertification. Once you qualify for a private consolidation loan, you’re set. You have the same fixed payments to cover unless you choose to refinance down the road. On the other hand, if you consolidate federal loans and use a hardship-based repayment plan, you must recertify annually. Basically, you must recertify that you qualify for hardship based on your Adjusted Gross Income and family size.

Annual recertification can be a pain, especially if your loan servicer doesn’t remind you, which often happens. If you don’t recertify, you can get dropped from the program. So, you have to know when your recertification date is and be proactive about applying each year.

There are some cons to private student loan consolidation.

If you have a career in public service working as a teacher, nurse, firefighter, police officer, EMT, or the military, you may want to consider Federal Direct Student Loan Consolidation over private because you won’t qualify for loan forgiveness with a private student loan consolidation. Under the Public Service Loan Forgiveness program, federal student loans can be consolidated, and after 120 payments, or 10 years, the remaining balance owed will be forgiven.

Another downside to private student loan consolidation is that monthly payments are not modified based on changes to your income or family size. Meaning that although you are likely able to afford the payments when you first sign up, there’s a risk that your financial situation could change. The only way to lower your payments would be to modify your consolidation loan and extend the term because federal hardship-based repayment plans would not be available.

What Other Options Exist to Pay Off Student Loans?

Student loan consolidation tends to be a smarter financial choice long term compared to deferment or forbearance for a few reasons. When it comes to deferment and forbearance, your payments may be temporarily suspended but interest continues to accrue, which is why most financial advice is to continue to at least pay the interest that accrues on your student loans.

If you are unable or choose not to pay the interest, your student loans essentially get more expensive. For example, if you have a student loan balance of $30,000 and are being charged an interest rate of 6 percent, you’ll acquire about $1,800 in interest payments during a year. If you are in forbearance and choose not to pay that interest payment, it gets added to the principal balance of your student loan. So instead of owing $30,000, you now owe $31,800.

Given that interest occurs on your principal balance, you’ll end up owing even more, and your monthly payment will increase in this scenario, which may make you question how helpful the year of forbearance actually was to your financial health. 

Because of these disadvantages when it comes to student loan deferment and forbearance, it’s often recommended to consider a different relief option such as private student loan consolidation or a federal income-driven repayment plan. 

Another option is to consolidate student loan debt with other types of debt such as credit card debt or auto loans into a personal loan. While having one loan with one creditor may simplify things, you’ll likely end up paying a much higher interest rate on your student loans this way. That’s because the average student loan interest rate is around 6 percent, while the average credit card interest rate is above 20 percent.

If you want to consolidate multiple types of debt such as student loans and credit card debt, it’s best to do so separately. Because your interest rate on the consolidated debt will be affected by your credit score, try to space out when you apply for consolidation loans. It’s usually best to apply for one loan at a time and if you’re attempting to consolidate both credit card debt and student loans, consolidating credit card debt via a debt management plan will likely increase your credit score more than consolidating student loan debt, so consider applying for credit card consolidation before applying to refinance your student loans. 

Another advantage of consolidating credit card debt first is that your credit card debt likely has a higher interest rate, and lowering your credit card interest rate and monthly payment could simply put more money in your pocket that you could apply toward your student loan debt.

Wondering if student loan refinancing is right for you? Contact DebtWave Credit Counseling, Inc. here for a complimentary budget analysis with one of our Certified Credit Counselors.

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