If you have student loans, chances are you’re dealing with multiple interest rates, multiple loan servicers and multiple monthly payments – a surefire recipe for multiple headaches. The idea of consolidating all your loans together sounds like a great way to simplify, but is that even possible when you have both private and federal loans? More importantly, is it advisable?
The short answer to the first question is yes, it is possible. But in order to decide whether it makes sense for your situation, there are some considerations to take into account. Here’s what you need to know:
The Term “Consolidation” Can Have Different Meanings
Consolidating student loans simply means combining them together, but there’s a difference between consolidating through the government’s Direct Loan Consolidation Program and consolidating through a bank or alternative lender.
When you consolidate student loans through the Direct Loan Consolidation Program:
- Most (but not all) federal loans are eligible, and private loans are not allowed.
- The resulting interest rate is a weighted average of the original loans’ interest rates, which means no money is saved.
- You may be able to select a new, longer term, which can reduce your monthly payments; however, a longer term can also end up costing you more money in total interest.
When you consolidate student loans through a private lender:
- In most cases, only private loans are eligible (although a handful of lenders accept both private and federal student loans).
- You’re offered a new interest rate based on your current financial situation, including your credit score (which means those loans are being refinanced as well as being consolidated).
- If you qualify for a lower interest rate, you may be able to reduce your monthly payments or shorten payment term, and you can save a significant amount of money on total interest.
Okay, so we’ve established that certain lenders will allow you to consolidate your private and federal loans together. Now let’s talk about whether that option is right for you.
When Refinancing Federal Loans Is a No-Brainer
The interest rates on federal loans are all one-size-fits-all numbers determined by Congress, so everyone gets the same rate for the same type of loan regardless of their unique financial situations. This can be advantageous for some borrowers – for example, undergrads who have little-to-no credit history and income. But borrowers whose finances and credit improve after graduation may find they’re eligible for lower rates through a private lender. This is particularly the case for mature borrowers who take out higher-rate federal unsubsidized or PLUS loans for graduate, MBA or professional degree programs. (You can see how your credit standing affects your cost of debt over time using this calculator.)
Unfortunately, many borrowers who would qualify to refinance don’t even realize the option exists for federal loans – mostly because it only became available in the past few years. But as awareness grows, so does the number of borrowers who take advantage of refinancing. In fact, the majority of SoFi’s $1 billion in funded loans is made up of refinanced federal student loan debt. (Full disclosure: I work for SoFi.)
Before refinancing federal loans, it’s important to note that some of these loans have features that don’t transfer to private lenders through the refinancing process. There are three main examples:
- Deferment/forbearance. Some (but not all) private lenders have a forbearance option in the case of unforeseen financial hardship, for example if you’re laid off from your job. The details of each lender’s offering will be different, so it’s good to learn what it is before refinancing.
- Income-driven repayment. Many federal loans offer the option of an income-based repayment plan, such as Pay As You Earn (PAYE), which allows you to make reduced monthly payments based on your income level. Most borrowers who qualify to refinance with a private lender at a lower rate don’t typically benefit from this program because their income is too high, but if you’re unsure, you should do the math on your own loans before refinancing.
- Potential loan forgiveness. The three most common forgiveness options are for borrowers who teach, work in the public sector or participate in one of the aforementioned income-driven plans. You’ll want to read up on these forgiveness options to see if you qualify before refinancing federal loans.
Bottom line? If your priority is saving money, then refinancing both federal and private loans can be a great strategy. The benefits of consolidating – simplifying your life with one monthly bill and payment – are simply an added bonus.
This article is intended to provide useful information about personal finance, but it is not intended to provide legal, investment or tax advice.
More on Student Loans:
- A Credit Guide for College Graduates
- How to Pay for College Without Building a Mountain of Debt
- Strategies for Paying Off Student Loan Debt