Student Loans: Consolidating vs. Refinancing

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There are many different reasons you might be looking to re-evaluate the terms of your student loans. Are you looking to lower your monthly payment to help manage cash flow? Are you looking to lower your interest rate? Maybe you are even looking to reconfigure your loans so your co-signer can be taken off the bill. No matter what’s led you to the decision to rethink your student loans, you’ve probably come to the same fork in the road: debt consolidation versus refinancing.

Let’s first cover the difference between these two options, then highlight which might be the best fit for you. 

Federal Debt Consolidation

Most folks with federal student loans know they have a total balance to pay back that represents the sum total of their year(s) in school, but not all borrowers realize that the total balance is actually broken down into smaller loans for each individual semester. Likewise, the monthly payment, while it can be paid in one installment, actually gets divided up among your multiple smaller loans. The act of consolidating student loans, then, is rolling many smaller federal loans into one larger federal loan. Private student loans cannot be consolidated.

With debt consolidation, your interest rate will be an average of the student loans you already held and isn’t really up for debate. So why consolidate if the interest rate won’t be lowered? Here’s why:

Your repayment timeline will usually change, giving you more time to repay your debt. Because the debt is being stretched over more years, you have the option to elect a lower monthly payment. This can be super helpful if you are focusing on more pressing financial goals like building an emergency fund or paying off higher interest debt like credit card balances. But remember that lower payments don’t necessarily mean money saved! Because the repayment terms are elongated you may pay more in interest over time. 

Additionally, consolidating will unlock income-driven repayment plans for all federal student loans. While most already come with this option, some federal loans such as the Parent PLUS loan cannot be put on an income-driven repayment plan until consolidated into a direction consolidation loan. 

Two more things to note are that if consolidation sounds like a good fit for you, it can be done at no cost. You don’t need to undergo a credit check like you do when taking out a new loan. Lastly, the consolidation of federal student loans cannot be undone. This doesn’t mean you can’t change your payment plan, you can always visit studentaid.gov to review your options, but you cannot go back to having multiple smaller loans once consolidated. 

You can use a service like Savi to find out whether you can save money on your student loans and whether you have access to forgiveness programs.

Refinancing Private Student Loans

Refinancing can look very similar to consolidation but should usually be reserved for private student loans, even though you can refinance federal student loans. The act of refinancing refers to taking out a brand new to pay off an existing loan, ideally with better term agreements. Depending on what you prioritize, your new loan could have lower monthly payments, a better interest rate, or sometimes both!

Because this is a brand new loan, you’ll want to look at a few things before moving forward with refinancing. First, you’ll want to confirm that your credit score is in good shape. Your credit score will be a determining factor in the rates your lender offers you, so head over to Credit Karma ahead of time to see if there is anything you can do now to bump your score up! 

Secondly, you should confirm that the origination fees (aka the price to start up the new loan) are worth the benefits that you are seeking. If the origination fee will cost you just as much as you’ll save on interest, you should look elsewhere. On the flip side, some lenders will even offer loans with no origination fees or even slight incentives (think $300 off your loan balance) to refinance with them, confirm that this cash incentive now doesn’t mean you pay more in the long run. 

Unlike consolidation which can only happen once, you can refinance your private student loans as many times as you see fit. Reasons for refinancing multiple times might include needing a new monthly payment, or a significant increase in credit score that could lead to a lower interest rate. That being said, most people will only need to refinance once, maybe twice over the life of their loan. 

So which is best for you?

If you have private student loans, the answer is simple, you will need to refinance. If you have federal student loans, you have to make a choice, as both debt consolidation and refinancing are technically available to you. But I argue that the decision is still fairly straightforward. Federal student loans come with a number of perks that most private student loans cannot offer. Federal loans offer more flexible deferment and even forbearance options for individuals who need financial assistance and, as we have recently seen, when the whole world needs financial aid. In the wake of the Covid-19 pandemic, the federal government waived student loan payments for federal borrowers, which is just one example of a benefit that would be lost upon refinancing with a private lender. So even when a private lender might be able to offer a slightly lower interest rate, debt consolidation is best for most federal borrowers. 

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