I've said it before:
Federal student loan borrowers should not consolidate their student loans to get a lower interest rate.
Here's why I say that.
Federal student loan consolidation doesn't give you a lower rate on all your loans.
Instead, it gives you a weighted average of all the loans you're consolidating.
Let's say you have 5 loans and you owe $20 thousand for each ($100 thousand total). For two of the loans, the interest rate is 4% and for the other three, the interest rate is 8%. Your new Federal Direct Consolidation Loan will have a new interest rate of 6.4%.
Have you lowered interest rate with the new loan? Sure, for the loans that were at 8%, you lowered your rate by 1.6%. But for the loans with an interest rate of 4%, you increased your rate by 2.4%.
Why You Shouldn't Refinance Federal Loans with Private Loans
IMO there are few instances when it makes sense to refinance your federal student loans with your private student loans. You'll lose eligibility for student loan forgiveness programs, deferments, and income-based repayment plans. Instead, you should look to private student loan consolidation/refinance to get a new interest rate. Note, as part of the private student loan refinancing process, the private lender will pully your credit report to see your credit history and credit score. So if you've missed some of the loan payments on your private loans, you'll likely be denied.
The only way to get an interest rate discount from the federal government is to sign up for automatic payment with your loan servicer. Signing up for autopay will save you .25% on your interest rate.
When Consolidation is the Right Choice
Now that I've made it clear that you shouldn't apply for a federal loan consolidation to get a lower interest rate, let's talk about when you should consolidate.
You should consolidate to:
- Get a better repayment plan based on your income
- Qualify for the Public Service Loan Forgiveness program
- Get out of default
- Get an income-contingent repayment plan for your Parent Plus Loans
- Make it easy to keep track of and pay off your student loan debt
I'll explain more about those reasons to consolidate later. But before I do, let me share one other reason to get a federal consolidation loan: to change your loan servicer.
As part of your loan terms, consolidation allows you to choose which loan servicer you want to handle your repayment options. So if you want to change servicers, consolidation makes sense.
Okay, onto explaining when you should consolidate...
1. Get a Better Repayment Plan
When you start looking at the monthly payment due and think to yourself I can't afford this, a Direct Loan consolidation may help.
Let me explain.
As you know, the U.S. Department of Education offers monthly payment plans based on your income.
The plan that offers the lowest monthly payment is the Revised Pay As You Earn and the Pay As You Earn Plan.
Not everyone with federal student debt is eligible for the REPAYE or PAYE repayment plans.
Only those with Direct Loans are eligible.
So if you have loans made under the Federal Family Education Loan program or the Perkins Loan program you could get a lower payment if you consolidate.
2. Qualify for the PSLF Program
In 2018, tens of thousands of teachers, policemen, firefighters, and other government and nonprofit employees applied to get their loans forgiven under the PSLF program. They each thought they met the requirements of the program.
Instead, most of their applications were denied. Only a handful were approved.
For many borrowers, their applications were denied because they didn't have Direct Loans.
Sure, they had federal loans. But they didn't have the right type of federal loans. They had FFEL loans and Perkins Loans.
So instead of getting their loan balance forgiven, they have to start the process over by submitting a consolidation application through studentloans.gov.
3. Get Out of Default
Consolidation is the fastest way to get out of student loan default.
It gets you out of default about 4 times faster than the loan rehabilitation program, which requires you make 9 monthly on-time payments.
When you consolidate, you'll combine all of your federal loans that are in default into a single loan that you'll make one single payment on each month.
While consolidating out of default sounds great, it does come at a huge financial cost in the form of capitalization.
Your new loan amount will include the principal, interest, and collection fees for each of the loans you consolidated.
4. ICR for Parent Plus Loans
Parent Plus loans are literally the worst of all the federal student loans when it comes to their repayment terms.
On their own, Parent Plus loans don't qualify for any of the income-driven repayment plans.
The only way to get them to qualify for one of those plans is to consolidate them into a Direct Consolidation Plus Loan.
But here's the catch.
A consolidation loan that paid off a Parent Plus loan is eligible only for the worst of all the IDR plans: the Income-Contingent Repayment plan.
The ICR plan is more expensive month-to-month than the IBR, REPAYE, and PAYE plans.
But when you have Parent Plus Loans this is your only option for a payment plan based on your income.
5. Make it Easy to Pay Off Your Debt
The final reason to consolidate is to make it easy to keep track of and pay off your student loan debt.
When you consolidate all of your federal student loans, you'll have one loan.
Technically, it'll be two loans. One subsidized loan and another unsubsidized loan.
Having one loan with one servicer makes it easier to know where your current loans are, how much you owe, what your loan repayment options are, and how long it's going to take you to pay off the loan.
So if you're someone who values simplicity, consolidation may make sense for you.