Borrowers who consolidate and refinance student loan debt combine two or more loans into one new loan with just one monthly student loan payment, streamlining the repayment process. Consolidation and refinance also provide borrowers with an opportunity to reduce the monthly loan payments by increasing the repayment term. But, there are important differences between consolidation and refinance, such as the impact on interest rates and borrower benefits.
Federal student loan consolidation is provided by the federal government through the U.S. Department of Education. Through this program, the new interest rate is based on the interest rates of your current loans you’d like to consolidate.
Since , the interest rate for the Federal Direct Consolidation Loan program is the weighted average of the interest rates on the existing loans that were included in the consolidation loan, rounded up see here to the nearest 1/8th of a percent, without a cap.
The use of the weighted average more or less preserves the cost of the underlying loans. There is no credit check required as part of a Direct Consolidation Loan as all borrowers with eligible loans .
A federal consolidation loan may be used to consolidate only federal education loans, such as Federal Stafford Loans, Federal Grad PLUS Loans, Federal Parent PLUS Loans, Federal Perkins Loans and Federal Consolidation Loans. The borrower must be the same on all the loans included in the consolidation loan.
More than a third of federal student loan dollars are in federal consolidation loans made to more than a quarter of federal student loan borrowers.
Be careful when refinancing federal student loans into a private loan , as the new loan will not include the superior benefits and protections of federal education loans. These benefits include low fixed rates, flexible repayment plans , longer deferments and forbearances, death and disability discharges, and loan forgiveness programs.
Change in Repayment Plan
When a borrower consolidates or refinances their student loans, they may have the option of choosing a new repayment term or repayment plan.
A longer repayment term will lower the monthly loan payment, but it will also increase the total interest paid over the life of the loan.
For example, increasing the repayment term on a $10,000 loan with a 5% interest rate from 10 years to 20 years will reduce the monthly payment by more than a third, from $ to $, but will more than double the total interest paid over the life of the loan, from $2, to $5,. Total payments, including principal and interest, will increase by about a quarter.
Beware: Even though some lenders refer to a lower loan payment as saving money, it may actually increase the cost of the loan.
A federal consolidation loan restarts the repayment term. This will yield a lower payment even if the borrower sticks with a standard 10-year repayment term. It can also reset the clock on public service loan forgiveness.
A private refinance may require a shorter loan term for a fixed interest rate, but may be more flexible on the repayment term for variable interest rates.
You could save money by refinancing
A private refinance can save the borrower money, if it results in a lower interest rate. However, most of the savings comes from having a shorter repayment term than a lower interest rate. Borrowers can get the bulk of the benefit by increasing the amount they pay each month.
Our Loan Refinancing Calculator shows you how much you can lower monthly payments or total payments by refinancing student loans into a new loan with a new interest rate and new repayment term.
Consider the pros and cons of student loan refinance before you decide. Refinancing federal loans into a private loan means you will lose all of the federal loan protections, such as income-driven repayment options, potential for loan forgiveness and a generous deferment period if you lose your job or have an economic hardship.
If you decide that student loan refinancing is right for you, check out our list of the best lenders to refinance student loans.