What to consider when combining multiple loans
Congratulations, you’ve got your degree in hand and you’re off to explore the future in your dream career! Unfortunately, that degree may have cost a pretty penny, leaving you with student loan payments moving forward.
Identifying your student debt repayment goal and finding the smartest way to achieve that could simplify the repayment process and help you stick to a budget with more reasonable payment amounts. Loan consolidation or refinancing are two options that may help you accomplish those goals. Let’s review how each strategy works and how to choose the best option for your financial situation.
What's the difference?
Although these terms are sometimes used as synonyms, “consolidation” and “refinancing” are two separate repayment strategies for borrowers with multiple loans.
Loan consolidation applies only to federal loans. It involves combining multiple federal student loans into a single loan with a fixed interest rate. The new interest rate is calculated as the weighted average of the previous interest rates, rounded up to the nearest one-eighth percent.
Loan refinancing involves obtaining a new loan to pay off existing student loans, and this applies to both federal and private loans. Refinancing replaces the previous group of loans with a single loan that often comes with a different interest rate and repayment terms.
Why consolidate?
Consolidating your federal loans may improve your financial situation and possibly preserve some federal loan benefits. Here are some advantages to consider:
- Simplified Repayment: Consolidating loans streamlines the repayment process by transforming multiple payments into one, reducing the chances of missing due dates and incurring late fees.
- Fixed Interest Rate: The new fixed interest rate provides stability, protecting you from fluctuations in the market interest rates. This predictability makes budgeting and financial planning more manageable.
- Access to Income-Driven Repayment Plans: Consolidation qualifies borrowers for federal income-driven repayment plans, which cap monthly payments based on income and family size.
- Loan Forgiveness Eligibility: With consolidation, you maintain the ability to qualify for a federal loan forgiveness program.
- Lower Payment Potential: You may have the option to choose a loan with a longer term, which could result in a lower monthly payment.
As with any decision, there are some drawbacks to consider:
- Loss of Benefits: Consolidating federal loans may result in the loss of certain borrower benefits, such as interest rate discounts, principal rebates, or loan cancellation benefits.
- Extended Repayment Period: While consolidation may lead to lower monthly payments, it also could extend the overall repayment period, resulting in more interest paid over time.
Why refinance?
If you have a mix of private and federal student loans, refinancing may be the solution for you. Here are the benefits to consider:
- Lower Interest Rate Eligibility: Refinancing allows borrowers with a good credit history to secure a lower interest rate, potentially saving money over the life of the loan.
- Lower Payment Potential: A lower interest rate or a longer loan term (or both) could result in a lower monthly payment.
- Simplified Repayment: Similar to consolidation, refinancing simplifies the repayment process by consolidating multiple loans into one, often with a single monthly payment.
- Rate Options: Borrowers can choose between variable and fixed interest rates, providing flexibility in loan terms and payment management based on their financial situation.
On the other hand, here are some disadvantages of refinancing:
- Loss of Federal Loan Benefits: Refinancing federal loans with a private lender means sacrificing federal loan benefits, such as income-driven repayment plans, loan forgiveness, and deferment options.
- Credit Requirement: Refinancing typically requires a good credit score, which may be a barrier for some borrowers. Those with lower credit scores may not qualify for favorable interest rates.
Which is right for you?
Choosing between the two strategies comes down to one factor: you. Loan consolidation may be an excellent option to simplify payments while maintaining access to federal benefits like income-driven repayment plans. At the same time, refinancing may be the desired route if you're seeking lower interest rates and more flexibility. Consider your current financial situation and your goals during (and after) the repayment period to decide what’s right for you.
For more on student loans and repayment options, check out our helpful mini-course Understanding Your Student Loans. Additionally, check out this article to understand how student loans affect your credit score.
