Student Loan Debt Consolidation vs. Refinancing

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Got student loans? You’ve likely looked into ways to make your debt more manageable and affordable. Some terms you might have seen thrown around are “consolidation” and “refinancing”. Truth be told, often these terms are used interchangeably, but there is a difference.

Debt consolidation vs. refinancing

Student loan debt consolidation is the process of combining your loans into a single monthly payment. If you have federal student loans, you can apply for a Direct Consolidation Loan. Under a Direct Consolidation Loan, you’ll simplify the repayment process and have a single payment. Your interest rate will be a weighted average of all of your loans that you consolidate. You can talk to your loan servicer or apply on StudentLoans.gov.

Remember this option is only for federal student loan borrowers and the Direct Consolidation Loan is from the U.S. Department of Education.

Refinancing is similar but not the same. When you refinance, you take out a new refinancing loan at a better interest rate. The new loan pays off your old loans and you then have a single monthly payment, at a better interest rate.

So it’s like consolidating in the sense that it also simplifies your student loan payments. You have one monthly payment instead of multiple payments. But the main goal of refinancing is to get a better interest rate.

Federal student loan interest rates are fixed, meaning they don’t change. If you feel stuck with that interest rate but want to lower your rate, refinancing is an option. In some cases, you may be able to cut down your rate a few points and even save thousands of dollars.

By doing so, you can tackle the principal interest and get out of debt faster. Win-win, right? Before you go refinance your student loans, though, there are some major things to consider. First, when you refinance your student loans, you’re working with a private lender.

You may have heard of student loan refinancing companies like SoFi. When you take out a loan with them, your federal loans get paid off. So essentially you are going from federal student loans to a single private loan, giving up any benefits you had with federal student loans.

Struggling and want to get on an income-driven plan? You can’t. Want to apply for student loan forgiveness? Definitely not an option with a private lender. So you want to be fairly certain you won’t need those benefits.

Another difference is the requirements. Nearly anyone with federal student loans can apply for a Direct Consolidation Loan. Refinancing loans require that you have good credit, stable income, and employment. Since you’re working with a private lender, they want to make sure you have the ability to pay back the loan.

Pros and cons of consolidation vs. refinancing

One major pro for consolidating and refinancing is the simplification of the loan process. If you have multiple loans, it can feel like a struggle keeping track of everything. Both of these processes make it easier.

Also, when you consolidate you may get a lower monthly payment as you can get a repayment term of up to 30 years. While that can be a pro, the con is that with a longer repayment term you’ll end up paying more in interest. Sometimes much more, so you want to calculate just how much!

A major con that you should be aware of with consolidation is that if you’re pursuing student loan forgiveness under Public Service Loan Forgiveness or income-driven repayment, any payments made toward these plans won’t count once you consolidate (ouch!). So be careful if that’s the route you want to pursue.

When it comes to refinancing, the main pro is to lower your interest rate and save money. You can go from fixed interest to variable interest and could pay off debt faster with the savings on interest. The major con though is that you are no longer eligible for income-driven repayment or student loan forgiveness because your loans are now private. There are few protections for private student loans compared to federal student loans.

Also, if you're interested in refinancing you want to make sure the cost savings is actually worth it to give up those benefits. In some cases, given your credit, you may not get approved for a better rate. You also want to know how your repayment term will affect your monthly payment.

Should you consolidate or refinance?

Whether you should consolidate or refinance is a personal decision. If your main goal is to save money, refinancing can help. If you want to simplify your payments, consolidating can be a good option. Like any loan-related decisions, you want to read the fine print, know your interest rate, repayment term and monthly payment. Think of the short-term and long-term benefits, weighing the pros and cons to come to a decision that works for you.