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Student Loans

Should I Refinance or Consolidate My Student Loans?

Refinancing and consolidation are two ways to bundle multiple student loan payments into one—and in the case of refinancing, potentially save money on interest. Whether to go for one of these options, though, depends on the type of loans you have and how much you stand to save.

Total student loan debt currently stands at about $1.5 trillion, according to the Federal Reserve, and it affects how borrowers can save, spend and set goals. A recent Federal Reserve report found that 20 percent of the drop in homeownership among 24- to 32-year-olds between 2005 and 2014 was due to an increase in student loan debt.

Here's how to decide whether refinancing or consolidating your student loans could make your finances more manageable.

How Do Student Loan Consolidation and Refinancing Work?

There are two methods for combining several student loans into one: federal consolidation and private consolidation, which is also known as refinancing.

In either case, you'll end up with a single loan payment, which can streamline your bills if there are several creditors billing you for separate loans each month. One payment could make you more likely to pay on time, which is the biggest factor in maintaining a strong credit score.

Refinancing has the added benefit of reducing the cost of your loans if you qualify for a lower interest rate or monthly payment. Be sure to weigh the tradeoffs before refinancing, though, especially if you include federal loans in the bundle.

Consolidating and Refinancing Federal Student Loans

Federal student loan consolidation is, as it sounds, available only for federal loans, or those the government makes. You do not need to meet credit requirements to consolidate federal loans, and after consolidating you'll pay a single bill to your student loan servicer, the company that accepts payments on behalf of the government.

But you also won't get a lower interest rate. Your new interest rate will be a weighted average of your previous loans' rates, rounded up to the next one-eighth of 1 percent. That means the interest rate on your largest loan balance will have the biggest impact on your final rate.

You can apply for a federal direct consolidation loan for free online through the U.S. Department of Education.

Federal Student Loan Consolidation Key Considerations

Consolidating federal loans comes with several unique benefits:

No credit or income requirements: Anyone with federal student loans can get a consolidation loan. Your credit scores, income and other financial factors are not used to determine your eligibility, and you don't need a cosigner. You may even consolidate as a way to get out of student loan default, as long as you either make three on-time payments beforehand or choose an income-driven repayment plan. More on those next.

Flexible repayment options: Federal student loan borrowers can choose among several repayment programs. The standard payback period is 10 years, but there are other programs, called income-driven repayment plans, that tie loan bills to income. Choosing one could make your payments much more affordable. Any remaining debt after 20 or 25 years of on-time payments toward an income-driven plan will be forgiven, though you'll pay tax on that amount. Certain public service workers may qualify for loan forgiveness in just 10 years, tax-free.

Extending your payback period can be tempting, since it will reduce your monthly payment. But the longer you take to pay off a loan, the more interest you'll pay over time. The sooner you can pay off your student loans, the sooner you can divert more of your savings to retirement, a home down payment or college savings for your kids.

Also, if you're already working toward federal loan forgiveness, consolidating loans may wipe out any credits you have already earned. Consolidating Perkins loans will disqualify you for forgiveness programs specific to those loans, but you can always leave them out of the consolidation process.

The ability to pause payments: Federal loans come with forbearance and deferment programs that let you take a break from payments if you lose your job, get sick or go back to school. If you don't know when you'll be able to get back on track, though, consider a longer-term solution like switching to income-driven repayment.

While it sounds morbid, federal loans are also forgiven if the borrower dies. That means your estate or heirs don't have to pay back the debt.

Consolidating and Refinancing Private Student Loans

Unlike federal student loan consolidation, refinancing is available for both federal and private student loans. A bank, credit union or online lender will pay off the loans you want to consolidate and issue you a new private student loan for the total balance.

Refinancing is credit-based, meaning your credit score is a primary factor in whether you qualify and the new interest rate you'll receive. The lender will also take your income and current debt-to-income ratio into account. If you're eligible for a lower rate than you currently pay, you could save a significant amount on interest, making it an especially appealing option for borrowers with high interest private loans.

Private Student Loan Consolidation Key Considerations

Before taking the plunge to consolidate and refinance student loans with a private lender, consider the following:

Your credit score matters: Those with high credit scores will get the lowest interest rates on a refinance loan. You'll be a strong candidate if your credit score is in the good-to-excellent range, which is 670 or higher using the ® credit scoring model. Check your credit report for errors and address them before you apply. That will help get your credit score in shape.

You can add a cosigner: If your financial background keeps you from qualifying for student loan refinancing, you have the option to use a cosigner. A parent, sibling or other responsible co-borrower can improve your eligibility or help you get a lower interest rate. Be sure that person understands the risks, though. They'll have to repay the debt if you can't, and that can be a major burden on parents nearing retirement age, for instance.

Variable interest rates may go up: Most refinance loans offer both variable and fixed interest rates. But variable rates are just that: variable, which means they can go up or down depending on economic conditions. It's hard to predict when the Federal Reserve will raise interest rates,so opting for a variable rate likely isn't wise unless you plan to pay off your loan quickly.

Look for discounts: Lenders often provide an interest rate discount for making automatic payments each month. If the lender is a bank, you could also qualify for a loyalty discount for paying your bill from an associated bank account.

Be Careful When Considering Refinancing Federal Loans

Private student loans, as a rule, don't offer the same flexibility federal student loans do. Turning federal loans private through refinancing is a big gamble: You'll lose access to income-driven repayment and long periods of deferment and forbearance. Check refinance lenders' policies on these features before signing any loan agreement.

If you have a strong income and job security and know you won't have to rely on federal loan benefits, however, refinancing may be worth the risk. Plus, you can always refinance your private loans only, or just a portion of your federal loans. An honest evaluation of your whole financial picture will help you make the decision that's right for you.


Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.

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