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Student Loan Consolidation: What You Need to Know
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Student Loan Consolidation: What You Need to Know

Thinking about consolidating your student loan debt but unsure what it entails? We can help you understand your options and figure out the best choice for you.

What is Student Loan Consolidation?

Student loan consolidation is a process that combines multiple student loans with different rates and term lengths into a single loan.

There are two main ways to consolidate your education loans:

  • Direct Consolidation Loan for federal student loans from the U.S. Department of Education.
  • Student loan refinancing from a private lender for a rate reduction.

What is a Direct Consolidation Loan?

The Direct Consolidation Loan process blends all of your existing federal loans into one new loan. With federal student loan consolidation, you now have only one loan payment due to one loan servicer each month with a new fixed rate. It’s important to note that any private student loans you have cannot be consolidated with a Direct Consolidation Loan.

While this can make your life easier from a payment perspective, direct student loan consolidation does not save any money. Your new interest rate with a direct consolidation loan is simply a weighted average* of your existing rates.

*How does a weighted average work? Say you have two student loans: one $10,000 loan with a 6% interest rate and another $5,000 loan with a 5% interest rate.  Calculating your new rate works like this: Because $10,000 is ⅔ of your total loan balance and $5,000 is ⅓, you’d multiply each interest rate by that fraction and add the results: (⅔ * 6% )+ (⅓ * 5%) = 5.67%. The weighted interest rate is then rounded up to the closest 1/8 of 1 percent (in this case, it would be rounded up to 5.75%). 

What is Private Student Loan Consolidation?

Unlike with a Direct Consolidation Loan, student loan refinancing (sometimes called private student loan consolidation), is applicable to both federal loans and private loans. You get a single new loan with a private lender, which pays off your existing loans. When refinancing your student loans, you are not only consolidating your loans, but also getting a new loan term and interest rate that depend on your current financial profile, rather than your previous loans’ rates and terms. This new interest rate can often reduce your interest cost significantly over your repayment period. You also may be able to release a cosigner you needed for the loan amount when consolidating your loans. 

Because student loan refinancing involves an evaluation of your current financial profile and credit history, it does require a hard credit pull. This can sometimes have a small (and often temporary) impact on your credit score. 

Besides a new interest rate, refinancing also offers a variety of repayment terms, giving you some choice in how much you pay each month. If you want to free up money in your budget with lower monthly payments, you can do that with a longer term. If you want to pay off your loan more aggressively with a shorter loan term, you can do that as well. You also have the option to pick between a variable interest rate and a fixed interest rate for your new loan. Ultimately, student loan refinancing provides a more customized repayment plan than student loan consolidation. 

Which are Eligible Loans for Private Consolidation?

You can refinance and consolidate both federal and private student loans. This includes all types of federal loans, including Direct Loans, Stafford Loans, Parent PLUS Loans, as well as private loans.

It’s important to note that when you refinance and consolidate, you can decide in your loan application which loans you want to refinance and which, if any, you’re happy to keep at their current terms. Some people may want to refinance all their loans, and for others it may make sense to only refinance some of them.

When you refinance federal loans and private loans into a one new private loan you will no longer be eligible to use repayment options included in the government’s income-based repayment programs or forgiveness programs like public service loan forgiveness. 

To decide, you should look at the loan repayment terms for each of your current loans—and whether refinancing can help you do better. You can get an estimated rate from Earnest in just two minutes.

Is it Smart to Consolidate Your Student Loans?

The main advantage of student loan consolidation is simplicity. Instead of making multiple monthly payments, you make just one student loan payment. This reduces the risk that a payment will slip through the cracks and affect your credit score. 

Federal consolidation may be a good option if you’re happy with the average of the interest rates on the loans you have, you are planning to use an income-based repayment program such as PSLF, or if you are working towards having good credit for refinancing. The important thing to remember is that while consolidation gives you the option to stretch out your repayment term with a lower monthly payment—doing so means you may pay more interest on your student debt over time.

Will Consolidating Student Loans Hurt My Credit?

In general, direct loan consolidation has no negative effect on your credit. Unlike student loan refinancing, the federal government does not require a hard credit pull (aka a credit check), a process that can have a small, short-term impact on your credit score and will show up on your credit report later. Consolidation allows you to choose a comfortable monthly payment, making it less likely you’ll miss a payment or make a late payment.

What are the Pros and Cons of Student Loan Consolidation?

The number one advantage of student loan consolidation is a simplified loan payment. You also have the option to select a longer loan term that can reduce your loan payment. Depending on the loans you have, there may be some downsides to student loan consolidation. Perkins loans, for example, may be forgiven for teachers and other public servants. Consolidating them would eliminate access to this loan forgiveness option. Additionally, any grace period or deferment you have with your current loan program also goes away if they are consolidated. 

Which Loans are Eligible for Private Consolidation?

You can refinance both federal and private student loans. This includes all types of federal loans, including Direct Loans, Stafford Loans, and PLUS Loans.

It’s important to note that when you refinance, you can decide which loans you want to refinance and which, if any, you’re happy to keep at their current terms. Some people may want to refinance all of their loans, and others may want to refinance only some of them.

Again, keep in mind that when you refinance federal loans and private loans into a new private loan, you will no longer be eligible to use the government’s income-based repayment programs.

To decide, you should look at the terms for each of your current loans—and whether refinancing can help you do better. You can get an estimated rate from Earnest in just two minutes, without affecting your credit score.

Which Should I Choose?

You should consolidate directly if: You should refinance (private consolidation) if:
You do not have a steady income currently. You do have a steady income or full-time job offer in hand.
You will be using an income-based repayment program. You will not be using an income-based repayment program.
You are satisfied with your current loans. You want to customize the term of your repayment according to your budget and save money through lower interest rates.

Learn more about refinancing your student loans

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Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.