How Does Student Loan Consolidation Work?

Student Loan ConsolidationIf you’re a college student or recent graduate, then you’ve probably thought more about student loans and how to pay them off than you’d like. With so much information out there, it may be difficult to figure out your best course of action. For example, many graduates have asked us how student loan consolidation works. While consolidating student loans is not the right choice for everyone, it can be a real help to some.

That’s why we decided to use this blog post to explain exactly what student loan consolidation is and whether or not it’s the right thing for you.

What Does Consolidation Mean for Student Loans?

Let’s start with the basics… How does student loan consolidation differ from the other types of debt consolidation? By definition, consolidation means combining many loans into one single loan. After consolidating, you have only one interest rate and make only one monthly payment, instead of having multiple rates and payments. Simplifying your life is a side benefit of consolidation – the main reason people do it is to get a fixed lower interest rate so they can pay their debt down faster.

The same is true for student loan debt consolidation, except that federal student loans cannot usually be consolidated with other debts. Private student loans can be consolidated with other debt in some case – for example by rolling them into a home equity loan (see below).

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What is Federal Direct Loan Consolidation?

As mentioned above, federal student loans are different. Since they are initiated by the Department of Education, federal student loans are eligible for Federal Direct Loan Consolidation. This is available to students who have Direct Loans or Federal Family Education Loans. These loans can be consolidated as long as they are not in in-school status – that means even if a student’s loans are in a grace period, repayment, deferment, or default, they can be consolidated.

Why does that matter? Well, federal direct consolidation loans can help you in a variety of ways. Not only do you get one monthly payment and (in some cases) a lower interest rate, but you will also continue to be eligible for benefits that apply to federal student loan borrowers, such as public service loan forgiveness and alternative repayment plans. These repayment plans include:

  • Standard Repayment Plan – Payments are a fixed amount each month and the loan must  be paid off within 10 years.
  • Graduated Repayment Plan – Payments start low and go up every few years, with the loan to be paid off in 10-30 years, depending on the amount you owe.
  • Extended Repayment Plan – Payments can be fixed or graduated, with the loan to be paid off over 12-25 years (available to those who owe more than $30,000).
  • Income Contingent Repayment Plan (ICR) – Payments depend on your income, loan amount, and family size, and the loan must be paid off in 25 years (any remaining balance after 25 years can be forgiven).
  • Income Based Repayment Plan (IBR) – Payment is capped at 15% of your disposable income and the loan must be paid off in 25 years. This option is only available to those who can prove partial financial hardship (any remaining balance after 25 years can be forgiven).

Can You Consolidate Private and Federal Student Loans Together?

No. In fact, private student loans are not eligible for consolidation through the Federal Direct Loan Consolidation Program at all. They can however, be refinanced separately. Two ways to do this are through a home equity loan (for homeowners only) or through education lenders. Before signing on the dotted line, be sure to evaluate any fees, whether or not the interest rate is fixed, and whether the lender charges prepayment penalties. Go to FinAid for a list of education lenders – but remember that for federal loans you will likely get the best rates and benefits by going through the Federal Direct Loan Consolidation Program.

In the past, students could obtain Federal Family Education Loans (FFEL), which were actually provided by private lenders and guaranteed by the federal government. These loans are no longer provided, although existing FFEL loans can still be consolidated under the Federal Direct Loan Program. This is the only case in which a “private” loan can be consolidated with a federal loan (since they are in fact guaranteed by the federal government).

Can You Consolidate Parent Plus Loans?

A Parent Plus Loan cannot be consolidated through The Federal Direct Loan Consolidation Program. Again, a parent can attempt to consolidate this in other ways (as mentioned above). However since this loan is already offered at a fixed rate, consolidation may not be necessary.

Can You Do IBR After You Consolidate Your Student Loans?

Yes, as mentioned above, federal consolidation loans are eligible for IBR and other alternative repayment programs. Whether or not you have regular federal loans or federal consolidation loans, you must prove partial financial hardship to qualify for IBR. Use this calculator to find out if you’re eligible.

Is It a Good Idea to Consolidate Student Loans?

The answer to this question depends entirely on your situation. There is truly no one correct answer for everyone. There are pros and cons to the Direct Consolidation Loans and each payment plan described above. To make it simple, here are the factors you’ll want to consider:

  • Is your particular plan eligible for forgiveness at the end? If so, you could save money on the part of the balance that is forgiven, but you may also need to pay taxes on that amount the year it is forgiven.
  • If you extend the life of your loan, you could end up paying more interest over the life of the loan than you would have otherwise. If you truly cannot make your payments then this could be worth it – but if you can make your payments you’ll want to do the math to make sure that this really makes sense to you.
  • If you consolidate your loan, the terms and conditions of that consolidated loan will override the terms and conditions of your previous loan. Check the benefits of each loan to determine which is better for you before making a decision to consolidate.

No matter what your situation is, we’d recommend using the free ReadyForZero tool to manage your student loans and track your debt payoff progress.

Image credit: lightpoet

This article is part of our Student Loan Debt Resource Center.  If you’re looking for additional information about credit card debt, be sure to pay a visit!

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  • SFS

    Thanks for this clearly written and informative article.

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