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Consolidating student loans can be a useful tactic to get a lower interest rate and simplify your payments. Managing student loans is a top priority for many, since student debt is now the second-largest type of debt in the U.S.—behind only mortgages—according to Experian data for the first quarter of 2019.
Your options for consolidating these loans depend on whether you have federal or private student loans, and your goals for consolidating. While consolidating federal loans through the government can simplify payments, it won't result in a reduced interest rate.
At the same time, consolidating federal loans using a private company such as a local bank means giving up potentially valuable repayment programs that could make your bill more affordable. Consolidating private loans is a safer bet.
Read on for the basics about the different types of consolidation, and when to pursue them.
Can I Consolidate Student Loans?
There are two types of entities that can consolidate student loans for you: private companies, like banks and online lenders, and the federal government. How to qualify depends on the type of consolidation you pursue. Let's break them down.
- Student loan consolidation through a private company: The goal of privately consolidating loans is to lower your interest rate. It's also referred to as refinancing. A private lender will pay off your current loan or loans and issue you a new one for the total balance you'd like to refinance. You can qualify for a new interest rate and terms based on your credit score, income, employment history and other financial factors. It's possible to refinance private loans only, federal loans only or both together. Your new loan will be private.
- Student loan consolidation through the federal government: The federal government also offers a consolidation option, but there's no credit check required, and it won't give you a lower interest rate. Instead, federal consolidation is a strategy to qualify certain loans for programs like income-driven repayment and Public Service Loan Forgiveness. You may also choose to consolidate federal loans if you want a single monthly payment or a fixed interest rate, since some older loans have variable interest rates. Your loans will stay federal.
Private Student Loan Consolidation
Consider private student loan consolidation, or refinancing, in the following circumstances:
- Your credit and income will qualify you. Generally, lenders look for good or excellent credit, which is typically a credit score of 670 or higher. You'll also need to demonstrate solid income and meet a lender's debt-to-income ratio (DTI) requirements. Your DTI is your total monthly debt payments divided by your gross monthly income, and the lower your DTI, the more likely you are to repay loans as agreed, in lenders' eyes. You'll likely have an easier time refinancing if your DTI is below 50%.
- You have high interest private loans. The biggest benefit of private student loan consolidation is the potential for interest rate reduction. Before moving forward, consider how much you stand to save from the process. You're most likely to see savings if you have high-interest loans—typically from private lenders—and you're eligible for a lower rate. Federal loans typically come with lower interest rates to start. Plus, refinancing them will mean giving up federal loan protections including payment reduction programs, long deferment periods and forgiveness options.
- You have access to a creditworthy cosigner. If you can't qualify for private student loan consolidation on your own, you can apply with a cosigner. That person will be responsible for repaying the loan if you can't, so make sure they understand the risks of cosigning. Some lenders will allow you to release the cosigner after a certain number of on-time payments, and if you meet other financial requirements. Check your loan agreement for a policy like this if you decide to use a cosigner.
If you decide to move forward with private student loan consolidation, here's how to do it:
- Check your credit score. First identify whether you're a good candidate for private consolidation. You can check your Experian credit score for free, and if it's not in the good to excellent range, explore cosigner options or consider working to improve credit before applying.
- See the rates you may qualify for. Many lenders offer the opportunity to prequalify for refinancing on their websites. They'll perform a soft inquiry, which won't affect your credit score, and you can compare likely rates from multiple lenders before submitting a full application.
- Choose your terms. Lenders generally offer multiple repayment terms, such as five years, eight years or 10 years. Pick the shortest term you can handle, which will keep your interest payments to a minimum.
- Gather necessary documents. When you've chosen a lender you'd like to work with, collect the documents you'll typically need to submit with your application. These can include pay stubs, tax forms like your federal W-2 form and a payoff statement telling your new lender how much of your current loan balance it will need to pay off.
- Keep making regular loan payments. During the refinancing process, continue paying your previous loans until your new lender confirms you can stop. That will help you avoid inadvertently missing a payment, which could hurt your credit score. You'll now make one payment per month to your new lender.
Federal Student Loan Consolidation
Federal student loan consolidation is, in most cases, a tactical move rather than a money-saving strategy. Here's when it makes sense:
- You must consolidate to qualify for certain repayment programs. If you have Federal Family Education Loans or PLUS loans, the government requires that you consolidate them into a direct consolidation loan to be eligible for some income-driven repayment plans. These plans lower your bill to a portion of your income. The same goes for the Public Service Loan Forgiveness program, known as PSLF, which provides loan forgiveness to public service workers after 120 qualifying payments.
- Simplifying payments would prevent you from falling behind. Consolidating federal loans gives you a single monthly payment. The downside, though, is that your interest rate will be the weighted average of your previous rates, rounded up to the next 1/8 of 1%; it will not be reduced. Your outstanding interest also gets added to your balance, meaning interest will accrue on a bigger loan amount. That means it's worthwhile to consolidate to simplify payments only if you're currently at risk of missing them.
You can consolidate federal loans for free online. Here's how:
- Choose the loans you want to consolidate. You don't have to include all your federal loans in the new consolidation loan. Perkins loans, for instance, come with forgiveness benefits you'll lose if you consolidate them. Consider consolidating only your non-Perkins loans.
- Choose a repayment plan. If you're consolidating to qualify for an income-driven repayment plan or PSLF, pick a new repayment plan for your consolidation loan. To do so, you'll submit a separate income-driven repayment plan request form online, and you can ask the government to put you on the plan with the lowest monthly payment if you're not sure which to choose.
- Submit a direct consolidation loan application online. You can complete the application online in a single sitting—it generally takes about 30 minutes. View a sample version of the application in advance to make sure you have all documents ready beforehand.
How Does Student Loan Consolidation Affect Credit?
If you consolidate federal loans to keep track of payments, student loan consolidation has the potential to protect your credit score. Payment history is the most important factor in calculating your credit score, accounting for 35% of your FICO® Score* . Prioritizing paying bills on time can keep it strong.
The same goes for private consolidation: While you likely already have good credit before refinancing, having only a single payment to manage can help you maintain it. The application process for private consolidation, however, may initially have a negative impact on your credit score, as it requires the lender to perform a hard inquiry when you apply. If your score dips, it will likely recover after a few months.
The Bottom Line
While private and federal student loan consolidation are approaches for borrowers with different needs, both require a thorough analysis of whether you're a good candidate. But the potential to enjoy a streamlined payment or lower interest rate could mean, mercifully, turning your focus to goals other than student loans.