Understanding Your Student Loan Options - Should I Consolidate or Refinance?

 If you are reading this you are probably like many other college graduates coming out of school with multiple student loans, wondering what the next best step to take is. Right now your loans may appear to be overwhelming and look like a mess with several payments you are or will have to make every month. Sometimes moving everything to one loan payment can help clear things up. That’s where direct loan consolidation and refinancing come into play.

You may be asking yourself many questions like, “Should I consolidate my student loans?” “Is it better to refinance them? "What even is the difference between refinancing and consolidating?"

Do these questions sound familiar? In an attempt to help answer these questions I have put together a quick guide explaining the pros and cons of both consolidating and refinancing student loan debt.

Here’s a closer look:

What is Direct Loan Consolidation?

Several borrowers graduate with federal student loans. All your loans probably have different interest rates as well as different repayment amounts. Direct Consolidation will help make this easier to look at because it is the process of rolling all those loans together into a single loan.

This new loan will have a fixed interest rate, based on the weighted average of all the loans you consolidated. The best part is, there is no fee to do it!

What kind of loans are eligible for Direct Consolidation?

Direct consolidation can only be done with federal loans, not private ones. Here is a list of all the eligible federal student loans.

• Direct Subsidized and Unsubsidized Loans
• Subsidized and Unsubsidized Federal Stafford Loans
• Direct PLUS Loans
• Federal Family Education Loan (FFEL) Program Loans
• Health Education Assistance Loans
• Federal Perkins Loans
• Federal Nursing Loans

Parent-Plus loans are an exception. Parent-Plus loans cannot be consolidated with other federal loans, but only with other Parent-Plus loans. Also, federal loans cannot consolidate with private loans (loans held outside of the federal system).

What is Refinancing Student Loans?

I hear the terms refinancing and consolidation used interchangeably all the time, but the reality is, they are two totally different strategies. As mentioned above, direct consolidation is rolling several federal student loans together. Refinancing is taking your student loans and moving them to a private lender, regardless of what type of loan you originally had. Federal or private, you can refinance them both into a new private loan. 

People often refinance their loans to help save thousands of dollars in interest by refinancing them at a lower interest rate. It is important to understand that by refinancing you become ineligible for federal programs like Public Student Loan Forgiveness (PSLF) and the ability to defer or go into forbearance. 

An example of this is Biden's $10,000 and $20,000 forgiveness relief program going through litigation. If that bill does go through, and you previously moved all your federal loans into a private loan, you more than likely will not qualify for Biden’s forgiveness program.

 When Does Consolidation Make Sense?

• You want to put your loans on an income-driven repayment plan or are working towards forgiveness.

 Not all federal loans qualify for loan forgiveness programs or income-driven repayment (IDR) plans. FFEL loans and Perkins Loans are examples of loans that do not. However, if you consolidate them into a Direct Consolidation loan, they can. This is probably the biggest reason people consolidate their student loans.

• You are looking to lower your monthly payments.

 When you initially start paying back your loans most of them tend to be on a 10-year repayment schedule. When you consolidate your federal loans, you may be able to extend your loan repayment term to up to 30 years. This will help lower your payment because you are paying them back over a longer period. Keep in mind, this might end up costing you more in the long run because the loan is stretched out allowing interest to build on it for a longer period.

• You want to have one loan repayment amount.

 Having to keep track of multiple loans can be a pain, especially if you have several loan servicers. Consolidating can help bring simplicity to an already complex situation.

When Does Consolidation Not Make Sense?

• You don’t want to be on an Income-Driven Repayment (IDR) plan.

 By consolidating into an IDR plan, you are stretching out your payments over a longer amount of time. If your goal is to pay your loans off quickly, consolidating them into an IDR plan would not make sense. 

• You are already on PSLF and have made qualifying payments.

 To qualify for Public Student Loan Forgiveness (PSLF) you must make 120 qualifying payments on eligible loans. Let’s say you already made 60 payments, and you decided to consolidate. Your payment count would be reset to zero. This is why it would not make sense to consolidate.

 (Note: Recent legislation has done away with resetting your loan repayment count. Check and see if this is still in effect if you are looking to consolidate while pursuing PSLF.)

• If consolidating raises your interest rate.

When you consolidate your loans, you will receive a new interest rate based on the weighted average of your old rates. It is possible that you may end up with a slightly higher rate. If this is the case, you would not want to consolidate and instead pay off your higher-interest-rate loans first.

When Does Refinancing Make Sense?

• You are looking to pay your loans off as soon as possible.

 Refinancing gives you the ability to reduce your interest rate. By reducing your interest rate, you are able to pay more on the principal of the loan, allowing you to pay off your loan quicker than you would with a higher interest rate on your loan.

• You want to reduce your interest rate.

 Refinancing your student loans can help reduce your interest rate, hopefully making your payments less expensive. This was the case during 2020-2021 when interest rates were very low. Some payments were reduced dramatically during this time.

When Does Refinancing Not Make Sense?

• You are pursuing PSLF or continue to want federal protections like deferment or forbearance.

If you are pursuing PSLF and decide to refinance into a private loan, you are no longer eligible for PSLF and lose access to all other federal protections.

For example, if you had federal student loans and were currently paying $0 a month because of the student loan payment pause due to COVID-19, and you decided to refinance your student loan. Your loan would no longer be a part of the student loan payment pause, and you would now need to start making payments.

 Conclusion

Consolidating and refinancing your student loans both have their advantages and disadvantages. Take time to look over your student loans to determine the right repayment strategy for you. By talking to a  trusted professional they can help guide you on what options are best for your specific situation. It can also help save you money and headaches in the long run.

ABOUT Vince darling CFP®

Hello, my name is Vince Darling,  a financial planner with The StoneBridge Group. I focus on bringing a personal side of financial planning to people through education and guidance. I am passionate about helping millennials and millennial small business owners of all income levels make great financial decisions so they can live the life they want to live. My office is based in Forest Lake, MN, but work with clients both locally and virtually.  You can follow the links to learn more about the StoneBridge Group and the services offered.