Consolidation. Refinancing. Direct Consolidation loan. The terms are enough to make your head spin. Even student loan experts agree that giving advice about consolidating student debt is complicated, riddled with answers including “if” and “it depends.”
“There’s a reason why borrowers are confused,” says Persis Yu, director of the National Consumer Law Center’s Student Loan Borrower Assistance Project.
Yu says the confusion starts because many borrowers don’t understand their loan types, whether they’re federal direct loans, Federal Family Education Loans (FFEL), or private loans. It persists because there are numerous reasons borrowers should or shouldn’t consider consolidating.
Although it’s hairy, consolidation is a good option for some student loan borrowers. To help you make sense of it all, we debunked five of the most common misconceptions about student loan consolidation.
Myth 1: Consolidation is the same as student loan refinancing.
Truth: Consolidation and refinancing are similar, but there are important distinctions.
You may have heard the words “consolidation” and “refinancing” used interchangeably, but they’re actually two distinct repayment options. Consolidation typically refers to bundling multiple federal loans into one through the federal government. It can make your monthly payments simpler or give you access to more favorable repayment plans or forgiveness programs. Learn more about consolidating your student loans on the government’s student loan site.
Student loan refinancing refers to taking out a new loan — usually one with a lower interest rate — to repay one or more existing loans.
Consolidation and refinancing are essentially the same when it comes to private loans, which is why people often conflate them. That’s not the case for federal loans, but more on that below.
Here’s a breakdown of the differences between consolidation and refinancing for federal and private loans:
|Federal student loans||Private student loans|
|Consolidation||Federal Direct Consolidation loan||Private lender
|Refinancing||Refinance through a private lender, lose federal loan benefits||Private lender
Myth 2: The consolidation process is the same for both federal and private student loans.
Truth: Federal loan consolidation is different from private loan consolidation.
Federal loan consolidation is a government process, while private loan consolidation happens through private lenders. If you have both federal and private loans, you may want to consolidate your federal loans together and your private loans together, but it’s rarely advised to consolidate them all into one loan.
To consolidate your federal student loans, apply for a federal direct consolidation loan on the Federal Student Aid website. Keep in mind that federal loan consolidation won’t typically lower your interest rate. Direct consolidation loan interest rates are fixed, and are calculated by taking a weighted average of the interest rates of the loans you’re consolidating.
Unlike federal loan consolidation, private loan consolidation involves applying for a new loan. Your prospective lenders will evaluate you largely based on your credit history and, if you qualify, make you an offer.
Some lenders will consolidate only private loans, while others — including the lenders participating in the refinancing marketplace Credible — will consolidate both federal and private loans. Through Credible, NerdWallet’s partner, you can apply to multiple lenders with a single application.
Myth 3: Consolidating your student loans is a no-brainer.
Truth: Student loan consolidation isn’t right for everyone.
Federal student loan consolidation sounds great: You go from juggling multiple interest rates, terms and loan servicers to having one monthly payment. But consolidation isn’t for everyone, says Rick Ross, co-founder of the consulting firm College Financing Group.
Federal loan consolidation can be beneficial if you need to do it to access a repayment option. For example, most income-driven repayment plans and forgiveness programs require that borrowers have a federal direct loan. If you have a loan from the Federal Family Education Loan program, you’ll have to switch to a direct consolidation loan to access those options.
But consolidating your student loans can also cause you to pay more interest over time. Federal Direct Consolidation loan term lengths range from 10 to 30 years, depending on your loan balance. The larger your balance, the longer your term will be. While a longer term will lower your monthly payments, it will increase the amount of interest you’ll pay.
Still, even if you get a direct consolidation loan with a long term, there’s no penalty for paying it off early. You should aim to pay off your loans as fast as possible to save the most in interest.
Myth 4: You can refinance federal student loans through the federal government.
Truth: Only private lenders offer student loan refinancing.
You can refinance both federal and private student loans, but only through private lenders. Although it issues student loans, the federal government doesn’t offer student loan refinancing. Some states have created their own refinancing programs, but even those are run through private lenders.
That means that no matter which route you go, if you refinance a federal student loan, it will become a private loan. You’ll lose the benefits that federal loans offer, including income-driven repayment plans, forgiveness programs, and deferment and forbearance.
Myth 5: Federal student loan consolidation costs money.
Truth: Consolidating your federal student loans is free — you shouldn’t pay a third-party company to do it for you.
Federal student loan consolidation is completely free through the federal government. But there are companies that try to capitalize on the convoluted consolidation process by charging for it. That’s a red flag, Yu says.
To avoid getting involved with a crooked student loan consolidation company, don’t give out your Federal Student Aid (FSA) ID, and don’t send your loan payments to a third-party company. For more information, read about four ways to spot a student loan scam.
- You can consolidate your federal student loans through the government by filling out a free application for a direct consolidation loan.
- You can refinance your federal student loans, but not through the federal government. You’ll have to go through a private lender, and you’ll lose out on federal loan benefits, including income-driven repayment.
- For private student loans, consolidation and refinancing are essentially the same thing.
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