18 Oct 2016

Understanding Whether – and, If So, When – to Consolidate Your Student Loans

Understanding Whether – and, If So, When – to Consolidate Your Student Loans

Student loans can be an overwhelming and confusing debt to manage.  For federal student loans in particular, there are myriad options available to lower or even temporarily postpone payments.  The key to managing student debt is not just to find the right option for you right now, but to create a long-term plan that will allow you to be debt free in the least amount of time, while spending the least amount of money.

Up until about 10 years ago, most federal student loan borrowers were advised to consider consolidating their loans.  This is because at that time, most student loans had a variable interest rate that adjusted annually and could go as high as 8.25% for federal Stafford loans and even higher for Parent PLUS loans.  Consolidation allowed borrowers to adjust the rate to fixed when rates were low and also lumped all the loans under one loan holder and one bill – making them easier to manage.  As there were few – if any – income-based repayment options at that time, consolidation was often the best way to lower the overall monthly payment.

These days, however, consolidation is not as beneficial for most borrowers.  Interest rates are fixed and the multiple income-driven plans available make it easier to obtain an affordable payment.  It used to be that borrowers consolidated their loans so that they would only have to keep track of one account and one bill. But since the federal government has made a point of minimizing situations in which borrowers have multiple loan servicers, borrowers are less likely to need to consolidate. 

Is Consolidation a Good Idea for Anyone?

The short answer is yes.  Consolidation can be a window to options that may not be available to some borrowers otherwise.  For example, federal student loan borrowers under the Federal Family Education Loan program (FFELP) are not eligible for the newer income-driven plans such as Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE).  These newer plans reduce the payment to 10% of the borrower’s discretionary income (rather than the 15% available under income-based repayment) and can offer forgiveness after 20 years under the plan for many borrowers (income-based repayment requires 25 years before forgiveness kicks in for all borrowers). 

FFELP borrowers can access these new plans by consolidating under the Direct Loan (DL) program at www.studentloans.gov.  This is also a good idea for any FFELP borrower looking to take advantage of Public Service Loan Forgiveness (PSLF) as that is also only available under the DL program.

Parent PLUS loan borrowers, who are not currently eligible for any of the income-driven plans, may also find an advantage to consolidation.  An obscure clause in federal law allows these loans to become eligible for a program called income contingent repayment by consolidating.  As Parent Plus loans are also eligible for PSLF, consolidating to take advantage of the income contingent plan may help these borrowers save significantly over the life of the loan.

What About Private Loan Consolidation?

For private loan borrowers, consolidation may offer the only way to lower payments.  As the private loan consolidation programs are quite competitive right now, and as borrowers likely have higher credit scores and incomes than they did when they initially applied for their loans, the chances of obtaining lower interest rates can also be very good.  Borrowers who have a spotty or limited repayment history with their current private loan holders may want to wait until after a year or two of on-time payments before applying to help ensure the best terms.  Consolidation can also be a good way to allow a co-signer to get off the hook for these loans.

Moving from Federal to Private Loan Consolidation

Very rarely does it make sense for consumers who have federal student loans to consolidate them with a private lender.  While you may end up with a slightly lower interest rate, consolidating a federal loan into the private loan program will cause it to lose all the benefits and protections currently available only under the federal program.  This includes income-driven repayment plans, forgiveness and deferment options, and discharge options  in the event of disability or death.  Only borrowers with secure employment, little additional debt and a very strong emergency fund should consider this strategy.

Consolidation is absolutely something that student loan borrowers should consider, but only if doing so will provide a good long-term solution to repaying this debt.  Remember, consolidation almost always extends the term of the loan, and the longer you take to repay, the more you will pay in interest.

Betsy Mayotte is the Director of Consumer Outreach and Compliance for American Student Assistance, a private nonprofit dedicated to eliminating finance as a barrier to education.  For questions, please email consumeradvocacy@asa.org

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