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Student Loan Basics: The Difference between Consolidating and Refinancing

Sep 02, 2020

Picking a student loan that meets your needs requires an understanding of some basic concepts. Student Loan Basics empowers you with information to make informed choices to borrow for college and manage the debt after college.

This article explains the important differences between consolidating and refinancing student loans.

Step 1: Understand the Terms “Consolidation” and “Refinancing”

The terms “consolidation” and “refinancing” are basically the same.  No matter how you say it, existing education loans are repaid with the proceeds of a new loan with a new interest rate and loan repayment term.

What’s different about them is how the term is applied:

  • Only loans made under the federal student loan program are eligible for the federal consolidation program.  As discussed below, federal loans may also be refinanced with a private lender.
  • Private student loans are not eligible to be consolidated under the federal program but may be approved for refinancing by a private lender.

To avoid confusing borrowers, private lenders no longer refer to combining outstanding education loans as a “consolidation.”  Private lenders may be banks, credit unions, finance companies, state-based agencies – basically everyone else except the government. Private lenders offer “refi” loans and the federal government offers “consolidation” loans.

This Student Loan Basics article “Choosing Federal and Private Student Loans” tells how to determine if you have a federal or private loan.

Step 2: Understand the Pros and Cons of Each Program

Each program has its benefits.  Borrowers with federal student loans may have an opportunity to either consolidate or refinance their loans.  Choosing an option that best fits your needs can help reduce the stress of student debt.

Benefits of consolidating with the federal government

Graduates with multiple loans may consolidate their federal student loans into one new federal consolidation loan. The old loans are repaid, and the borrower now has a new loan with one interest rate, one set of terms and conditions, and one student loan servicer.

Federal Direct Consolidation Loans offer:

  • Guaranteed approval in nearly all cases.
    • A new fixed interest rate equal to the weighted average interest rate of the loans being consolidated rounded up to the nearest 1/8 of 1% (0.125%).
    • Lower monthly payments by extending the repayment period up to 30 years.
    • Income-based repayment plans may reduce monthly payments but increase the number of payments.
    • Potential eligibility for Public Service Loan Forgiveness (PSLF) and/or certain income driven repayment options.

The flexible income-driven repayment schedules and potential for PSLF and other federal benefits including deferment and forbearance are very favorable.  These borrower-friendly terms are not found with private refinancing programs. Borrowers should carefully these provisions when choosing between a consolidation or refinancing.

Other considerations:

  • Once federal loans are consolidated, they cannot be consolidated again, unless a new federal Direct Loan is taken after the initial consolidation.
  • Private credit loans cannot be included in a federal loan consolidation.
  • The United States Department of Education the consolidation lender and uses non-government servicers to make and collect the loan.

Cons of Consolidating with the Federal Government:

  • The interest rate on the new loan will not be less than the old loans – and may be slightly higher because the interest rate is rounded up.
  • The total cost of the consolidation loan is likely be greater than the total of the loans to the consolidated.  Extending the payment period reduces the monthly payment but will result in paying more total interest.
  • Some borrowers may lose specific benefits associated with the old loans such as interest rate discounts, cancellation benefits and/or principal rebates.
  • Payments that were counting toward the required 120 payments for Public Service Loan Forgiveness (PSLF) on the old loan are not included in the required 120 payments for a PSLF on the new consolidation loan.  The 120 payment clock restarts for the new loan.

TIP 1: Don’t pay for help consolidating loans, you can do it for free through the Federal Direct Loan Program.

TIP 2: Be sure to continue making payments on the loans you plan to consolidate.           

Refinancing with a Private Lender

Unlike the government which makes a new loan to virtually everyone who wants one with identical terms, interest rate calculation and repayment option, private lenders have no such obligation. They may choose not to lend to a specific borrower and are not required to offer each borrower the same interest rates and terms.

As they do when lending for homes and cars, each lender establishes its own lending criteria, terms and conditions for their student loan refinancing programs. Generally, private student loan refis:

  • Are credit tested. Some borrowers will be rejected because they do not meet the lender’s requirements.
  • Offer pricing (interest rates) based on a borrower’s credit score. Borrowers with good credit are offered lower interest rates.
  • Allow borrowers to make choices about their loans:
    • Choose either a fixed or variable interest rate. This Student Loan Basics article, explains the difference between fixed and variable rate loans.
    • Select a repayment term, sometimes as short as five years, that best fits the borrower’s needs
  • Permit consolidation of both federal and private loans

The Pros and Cons of Refinancing

For student loan borrowers who have established good credit, the option to refinance student loans with a private lender may result in a lower cost loan.  They may:

  • Be offered an interest rate that is less, perhaps substantially, than the federal consolidation loan interest rate.
  • Choose a shorter payment period that results in a lower cost loan.

The significant downside of private loan refinancing is the loss of substantial benefits of federal loans, such as income-based repayment and loan-forgiveness options.  For borrowers with high credit scores and the capacity to forgo the federal benefits, the private refinancing market could be a good option.  They may be able to access a student loan refinancing more at a lower cost.

A final thought

Student Loan Basics seeks to explain some important fundamentals to empower families to make better choices when it comes to minimizing the cost of student loans.  For graduates with student loan debt, either “consolidating” or “refinancing” may be an important step in better managing their debt.