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Private Consolidation of Federal Loans

Several lenders of private student loans, including Citizens, SoFi, and CommonBond, are offering to consolidate federal education loans into private student loans for some borrowers.

When is private consolidation of federal education loans appropriate? When is it inappropriate?

Students should still borrow federal first, because federal student loans are cheaper, more available and have better repayment terms than private student loans. But, in some cases, parent borrowers of Parent PLUS Loans may be able to obtain significant savings by refinancing their PLUS Loan into a private student loan.

Since there are no prepayment penalties on federal education loans, nothing stops a borrower from refinancing federal education loans into a private consolidation loan, if the borrower can obtain a lower interest rate on the private loan.

Some previous borrowers of Parent PLUS Loans may have relatively high interest rates on their loans, interest rates as high as 8.5%. If these borrowers have excellent credit, with FICO scores of 780 or more, they may be able to qualify for fixed interest rates on private consolidation loans that are much lower than the current interest rates on their Parent PLUS Loans.

Assuming a 10-year repayment term, each percentage point reduction in the interest rate on a Parent PLUS Loan will save the borrower more than $500 in interest over the life of the loan per $10,000 borrowed. That’s a savings of more than $50 in interest per year. The total savings are greater if the private consolidation loan offers a much lower interest rate or if the borrower has a much larger loan balance.

Thus, these borrowers are faced with a tradeoff between obtaining a lower interest rate and losing some of the superior benefits of federal education loans.

But, the U.S. Department of Education does not offer as many benefits for Parent PLUS Loans as it offers for federal student loans like Direct Subsidized and Unsubsidized Loans, and the Grad PLUS Loan. Parent PLUS Loans do not offer subsidized interest benefits and Parent PLUS Loans are ineligible for income-contingent repayment, income-based repayment and pay-as-you-earn repayment. (A narrow loophole allows Parent PLUS Loan borrowers who entered repayment since July 1, 2006 to obtain income-contingent repayment by first consolidating their Parent PLUS Loans into a Direct Consolidation Loan.) While Parent PLUS Loans are technically eligible for public service loan forgiveness, there is no financial benefit to the borrower unless the loans can be repaid through one of the three income-dependent repayment plans.

Borrowers who consolidate Parent PLUS Loans into a private consolidation loan do lose some benefits. Federal student loans offer more generous deferment and forbearance options. Private student loans offer forbearances of up to one year in total duration, while federal student loans offer deferments and forbearances of up to three years. Unlike students, parent borrowers have sufficient money management experience to evaluate the likelihood of encountering financial difficulty. Moreover, parents who qualify for a lower interest rate on a private consolidation loan will generally have very high credit scores, demonstrating that they are good at managing their money and capable of making smart borrowing decisions.

Refinancing Parent PLUS Loans into a private consolidation loan is appropriate only if the borrower will obtain significant savings and only if the borrower is able to make an informed decision about the loss of repayment benefits on the Parent PLUS Loans.