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How to Consolidate Student Loans

It’s not uncommon to graduate college owing on multiple student loans. Each year students fill out the FAFSA® (Free Application for Federal Student Aid) and each year a new financial aid award letter is generated, which most likely results in another student loan to cover the entire cost of schooling that academic year.

For students with multiple loans, consolidation can help simplify the repayment process. Consolidating multiple student loan payments and potentially multiple monthly due dates will surely make repayment easier. However, the term consolidation shouldn’t be misunderstood as it has a unique meaning for federal student loans vs private student loans.

Federal Student Loan Consolidation

A Direct Consolidation Loan from the U.S. Department of Education is the compiling of multiple federal student loans into one single loan. This alleviates having to deal with potentially several loan servicers, each with their own payment schedules and simplifies your payment into one payment to one servicer each month. Additionally, a Direct Consolidation can extend the length of the loan up to as many as 30-years, which could lower monthly payments but ultimately cost more in interest overall.

Important to note – when federal loans are moved into a Direct Consolidation Loan the interest rate associated with each individual loan doesn’t change. The new consolidated loan will have a weighted average fixed-rate interest rate based on the loans being consolidated  and will be rounded up to the nearest 1/8th of one percent.

How to Apply for a Direct Consolidation Loan

Anyone with eligible federal student loans who has either graduated or has fallen below half-time attendance can apply to consolidate their loans. You cannot consolidate student loans that have yet to enter repayment , if you are in a grace period, it’s recommended to wait to consolidate, as you will lose the remainder of your grace period once the loan is processed, and you immediately begin repayment.

You can apply for a Direct Consolidation Loan by submitting your consolidation loan application either online or by mail—however, it is recommended that you complete your consolidate application online when possible. After submission, it’s important to continue making payments on your existing loans until the process is complete and you have a new consolidation loan servicer with a new payment and monthly due date.  Don’t worry if you make an extra payment, your previous loan servicer will either send it to your new servicer as a credit, or refund the payment to you.

Things to Consider Regarding Direct Consolidation Loans

When you consolidate multiple loans it’s important to know that any outstanding interest on your existing loans will become part of the principal balance of your new loan, potentially making your new Direct Consolidation Loan outstanding principal greater than the sum of the outstanding principal individual loan amounts on your existing federal loans. That’s because your servicer(s) managing your student loan accounts will typically hold accrued interest in a separate “bucket” unless they are required to capitalize that interest—which means, add it to your outstanding principal balance. Your servicers are required to capitalized interest before transferring your loan to your new Direct Consolidation Loan.

It’s also possible that you might forfeit some benefits when consolidating your federal loans into a Direct Consolidation Loan, such as interest rate discounts or cancellation benefits. For example, if you are consolidating a Federal Perkins Loan into a Direct Consolidation Loan, your Federal Perkins Loan will lose its subsidy Meaning, if you ever put your Direct Consolidation Loan in a deferment status, your previous Perkins balance will be considered unsubsidized loan funds and will accrue interest, or the Perkins loan cancellation benefit.

Private Student Loan Bundling and Refinance

You also have the option of bundling several private student loans together or even multiple federal and private student loans together. While some might call this bundling a ‘consolidation” the terms and implications are quite different for you the borrower.

Technically, this bundling of loans would be considered refinancing your student loan(s). In doing so, you have the potential of lowering your interest rate (not available with the Direct Consolidation Loan) as well as changing the repayment options and length of repayment. This may seem like an obvious choice, if you can lower your interest rate, but there are other financial implications of leaving the federal student loan program that should be considered before making the decision to do so.

Benefits of Student Loan Refinance

The biggest and most compelling reason to refinance your student loan(s) is to take advantage of lower interest rates than those you committed to when first accepting the loan. Lower rates could mean lower monthly payments, less money paid in interest overall and potentially paying off the loan sooner, should you opt to continue paying your same monthly payment with more money now going toward the principal bringing it down faster.

Another benefit of private student loan refinance is changing your loan terms. You could shorten or lengthen the loan repayment term of your loan to best suit your needs and ability to pay. Should you choose to lengthen the loan, keep in mind that more payments will mean more interest paid overall.  However, if your current situation requires you to lower your payment by extending the repayment term, you could always increase your payments later (if finances allow) to put you back on track to pay it off sooner. Many student loans, even a private student loan refinance, should not have prepayment penalties—but check your terms and conditions to make sure!

Finally, if your parents or some other person cosigned to help you get a loan while you were in school, refinancing is one way to remove the cosigner from the commitment. If you can show you are a credit-worthy borrower capable of making the payments on your own, you can refinance the loan in your name alone. You can take this opportunity to go out on your own to help continue build your credit score and establish a strong credit history, that will help you further down the road should you decide to buy a car or home or other major purchase.

Don’t fret if you are unable to qualify on your own, you can ask another individual (like a spouse or sibling) to cosign your new private student loan refinance.

Considerations if Refinancing Federal Student Loans

If all or some of your loans are federal student loans, you will want to carefully weigh the pros and cons before choosing to take your loans out of the federal student loan programs. Federal student loans offer a variety of programs to help struggling students that private loans may not. For example, there are income-driven repayment plans and forgiveness plans offered for federal student loan borrowers that would otherwise be forfeited should you move your federal loans into a private student loan.

Ultimately you need to decide if the lower interest rate is worth more to you than the repayment options offered for federal borrowers. However, should you decide that saving money is more important and are willing to forego the federal benefits, there are several private lenders out there who will compete for your business, so make sure to do your research and compare each lender carefully before deciding on one.

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