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If you're repaying several federal student loans, keeping up with multiple payments can be a headache, and forgetting to make a payment can result in late fees and a credit hit.
Consolidating federal student loans with a direct consolidation loan is a way to simplify payments by combining many loans into one loan. The loan consolidation program offered by the U.S. Department of Education is free and could be a good option if you'd prefer to manage one loan instead of many.
How Direct Loan Consolidation Works
Direct loan consolidation allows borrowers to take out a new federal loan to pay off existing federal student loan balances. This consolidation process turns many student loans into one with a single payment, which can make it easier to manage payments and could even lower your monthly payment.
Loan terms for consolidation loans can go up to 30 years depending on the repayment plan you choose, and the interest rate on your new loan will be the weighted average of the loans you consolidate, rounded up to the nearest one-eighth of 1%.
Most federal loans qualify for the direct loan consolidation. Here's a breakdown of loans that you can consolidate:
- Direct subsidized and unsubsidized loans
- Subsidized and unsubsidized federal Stafford loans
- Direct PLUS loans
- PLUS loans from the Federal Family Education Loans (FFEL) program
- Supplemental Loans for Students (SLS)
- Federal Perkins loans
- Federal nursing loans
- Health education assistance loans
If you have loans in default, they may also qualify for consolidation as long as you satisfy one of two conditions: You must either make three consecutive on-time payments on the defaulted loans or agree to sign up for an income-driven repayment plan with the new consolidation loan.
6 Steps for Consolidating Your Student Loans
Borrowers can apply for a student loan consolidation online or by mail. Here's a step-by-step overview of the process:
- Get your loan documents together. Put together your loan statements and bills to decide which loans you want to consolidate.
- Start the online or paper application. The beginning section of the application asks for information including your name, address, Social Security number and phone number.
- Choose the loans you want to consolidate. Choose which loans to include and exclude in the new consolidation loan. You can also note loans that are currently in a grace period, and the loan servicer will delay the consolidation until that period is over.
- Select your repayment plan. Borrowers can choose from income-driven repayment plans. The standard repayment plan, graduated repayment plan and extended repayment plan are other options that offer terms of 10 to 30 years.
- Wait for loans to be paid off. After applying, your loan servicer will handle the rest. Be sure to keep up with payments on your existing loans until funds from the new loan are disbursed to pay off the old balances.
- Make payments on the new loan. Once the consolidation is complete, the first payment on your consolidation loan will be due within 60 days of the loan disbursement.
Pros and Cons of a Direct Loan Consolidation
Before deciding to get a direct loan consolidation, it's important to consider the benefits as well as the drawbacks. While there are perks to consolidating student loans, there are some disadvantages to consider, especially if you're a borrower who's already made payments toward income-driven repayment loan forgiveness.
- Multiple payments turn into one payment. Having fewer loan payments to keep up with each month can minimize the risk of accidentally missing one.
- Consolidating may lower your monthly payment. Choosing a consolidation loan with a longer loan term could help you lock in a lower monthly payment. This could free up some room in your budget if payments are causing financial strain.
- Consolidating can get loans out of default. Consolidating is a way to get loans back in good standing so you can qualify for payment relief if you're experiencing financial hardship. Putting loans in forbearance or deferment isn't possible when your loans are in default—but consolidated loans become eligible for these benefits again if you meet the conditions explained above.
- Consolidating could erase payments toward loan forgiveness. Your loan can be forgiven after making payments for 20 to 25 years under an income-driven repayment plan. If you consolidate your loans, however, progress toward this forgiveness is erased, and you have to start from scratch. This is typically true for Public Service Loan Forgiveness as well, but under the COVID-19 relief plan, on-time payments you make on federal loans before consolidating still count toward forgiveness for a limited time.
- Consolidating to a longer loan term can be costly. Choosing a longer loan term for your consolidation loan could lower your monthly payments, but it could also increase the total cost of your loan over time since you'll be paying interest for a longer period.
- Consolidating could increase your interest rate. Rate discounts or deals you're currently getting won't cross over to your new consolidation loan.
- Unpaid interest gets added to your balance. If you went through a period of deferment or forbearance and you didn't pay interest, that interest may be capitalized and added to your new loan's principal. Interest added to a high loan balance can be costly.
The Bottom Line
Consolidating student loans is a way to restructure your federal loans to make them easier to repay, but it may not save you money long term. The direct loan consolidation program is designed to simplify payments for federal loan borrowers and not to save you on interest—as with other types of consolidation loans—since there's no interest rate reduction.
If you have strong credit, refinancing student loans with a private lender could help you secure a lower interest rate and long-term savings on federal and private student loans. Just keep in mind that using a private loan to refinance federal student loans means they'll no longer qualify for federal perks, like deferment, forgiveness and income-driven repayment plans.
The best way to manage your loans comes down to your finances, goals and credit score. Understanding the terms, rates and repayment terms of each option can help you come up with the best strategy for tackling your debt.