There are a handful of ways to reduce student loan payments. Two of those methods include student loan consolidation and student loan refinancing. These two terms are often used interchangeably; however, there are two distinct products/programs available to student loan borrowers. This article discusses federal student loan consolidation and private student loan refinancing. It bodes well to understand the difference.
Federal student loan consolidation refers to a program offered by the Federal government to federal student loan borrowers specifically. On the other hand, student loan refinancing refers to a product offered by private lenders to either federal or private loan borrowers.
In either case, student loan borrowers can take advantage and reduce their monthly payment by combining multiple student loans, but there are still a few key differences to consider before applying for either. Before making a decision to consolidate or refinance student loan debt, it is essential to understand what each is, and what each is not.
Should You Refinance or Consolidate Student Loans?
Let’s start with an overview of student loan refinancing and student loan consolidation. Both can be helpful, but one might be better than the other in certain situations.
Refinancing Your Student Loans
When you refinance student loans with a private lender, you can combine both federal and private student loans. This offers quite a bit of flexibility, allowing you to essentially convert both types of loans to just one owed to a single lender. However, there’s more to it than just combining your loans. Private student loan refinancing offers completely new loan terms to applicants, meaning you can get a new interest rate, new repayment term, etc.
There are a few key benefits that borrowers can take advantage of with a new set of terms. Qualified refinancing applicants may be able to reduce their overall interest rate on student debt; furthermore, they can usually choose between a variable or fixed interest rate. If you can reduce your rate and pay the loan on time, you’ll save money. With a new repayment term, student loan debtors can choose whether to extend or shorten their term – the former would reduce and the latter would increase the monthly payment. You can choose to either get a reprieve in monthly payments or expedite repayment entirely.
However, there are some drawbacks to refinancing. Private lenders require an applicant’s credit to be healthy and income to be relatively high and steady; they need to know that the borrower has the ability to repay the loan over time. If an applicant does not meet this basic criteria (or exceed that criteria), then there’s a very real chance he or she will not get a reduced rate. On top of this, transitioning federal loans over to the private sector effectively removes any prospect of federal benefits including loan forgiveness, deferment, etc.
Federal Student Loan Consolidation
Federal student loan consolidation differs from private student loan refinancing in that borrowers may only consolidate current federal student loans – not private student loans. The Federal Consolidation Loan program does not require solid credit history, so it is an option to federal student loan borrowers who may be struggling already.
There are a couple of specific benefits to federal consolidation. The first and simplest is fewer student loans to handle. Instead of several student loans to manage, you’re left with just one. Possibly the most important benefit is the ability to restructure the repayment term. You have the option of extending your term up to 30 years. If this is done, then you will see an immediate reduction in your monthly payment. If a borrower is struggling with payments, then a consolidation loan can be a lifesaver. Finally, federal student loan consolidation preserves certain federal benefits. For instance, borrowers still have the ability to select an income-driven repayment plan.
Of course, there are also drawbacks. Federal student loan consolidation does not lower the overall interest rate for borrowers. The new interest rate is a weighted average taken from all previous loans, so there is no rate reduction and no real way to save money on the cost of the loan. With that in mind, the next drawback becomes more significant. By extending your repayment term (a major incentive to consolidate), you are essentially keeping the door open for interest to accrue over more time. Assuming you pay on schedule, this will end up costing you more over the life of the loan.
Making the Call
Many of the basic benefits and drawbacks of refinancing and consolidation were listed above, respectively. So now it’s time to make the call. Here’s a bit of advice:
Student loan refinancing with a private lender is an ideal choice if, and only if, you’re in the right situation. The first question is whether you qualify for approval, and the next is if you’re able to get a rate reduction If you fit the bill, then student loan refinancing should be able to save you money if you pay the loan off on time. However, you need to weigh the savings against the loss of federal benefits. Will you need to defer your payments? Or are you going to qualify for student loan forgiveness later on? These are important questions to ask yourself.
If you decide you can’t qualify or really want to retain federal benefits, then you should steer clear of student loan refinancing. Applying for a new loan product will likely result in a hard credit pull, and you may end up either getting declined or left with a high-interest loan.
Student loan consolidation with the federal government is a good choice for anyone who’s struggling to pay their loans and needs a solution quickly. Being able to extend your repayment term will reduce your monthly payment, so you can get a reprieve that way. Just remember, it will cost you more over the life of the loan. This cost needs to be weighed against how much you need debt relief.
When Refinancing or Consolidating Student Loans Isn’t Necessary
Just because consolidation and refinancing are hot topics in the education financing world, it does not mean either option is the right fit for you. If your interest rates on one or more student loans are low and you’re managing your payments easily each month, then you may not need to refinance or consolidate student loans at all.
Similarly, if you have other options to reduce your monthly payment. You can opt for an income-based repayment program on federal student loans, so you may not need to consolidate or refinance in order to save your cash flow. Income-based repayment programs calculate your monthly payment based on a percentage of discretionary income.
Overall, you may benefit from a refinance or a consolidation when, and only when, you are able to create a payment strategy that works best for your current financial situation. If this isn’t possible, then you may be better off forgoing them entirely.
Can You Refinance After Federal Student Loan Consolidation?
If you get a federal consolidation loan but later decide that refinancing is a better option, you still have the opportunity to do so if you meet a private refinancing lender’s requirements. In short, the process doesn’t change if you’re trying to refinance a federal consolidation loan.
Like before, you will need to have a strong credit history, a steady income or verifiable employment, and in some cases, a cosigner. If you meet these qualification requirements, you may be able to lower your total interest rate with a private student loan, saving you money in the long run.
Just to reiterate, it is crucial to understand that you give up specific provisions which are inherent to federal student loans. These include income-driven repayment options, deferment and forbearance, and protections in the event of disability, death, or financial hardship.
Originally Posted On LendEDU