Student Loan Consolidation

Most college students finance their education with a patchwork of scholarships, grants and loans. The loans are often from a variety of lenders, both government and private, with both fixed and varying interest rates. For a new graduate, managing this patchwork of debt on top of health insurance and job-search worries can seem overwhelming.

Loan consolidation is supposed to help take some of the confusion out of paying off your student debt. When you consolidate, the Federal government—or your bank or credit union—pays off all your individual loans and issues you a new loan through their program. The new loan locks in a single fixed interest rate, often lower than previous variable rates. When you consolidate, you still have the same amount of principal—but you’re only paying one creditor, and your interest terms are often better.

When You Should Consolidate—and When You Shouldn’t

When you graduate, you’ll have a six-month grace period during which you don’t have to start paying off your student loans. This is your window of opportunity for loan consolidation.

In most cases, loan consolidation will lower your interest rates and eliminate the hassle of variable rates. Your lender assigns you a new interest rate by finding the average of all the interest rates you’re paying and rounding up by one eighth of one percent. The Federal government sets a limit on how much lenders can charge on consolidated loan interest, however, so your new interest rate may wind up being lower than your interest average. The Federal limits vary from year to year.

You should consolidate your loans if you have significant Stafford and PLUS loans with variable rates, if the government has set a low enough rate limit this year to allow you a good deal on a consolidation loan, or if the average of your current loans (rounded up by one eighth of a percent) will represent a break on your interest rates.

You may want to reconsider consolidation if your debt is mostly fixed-rate and low-interest to begin with—in this case, consolidation may not give you a significant advantage. Consolidating a low-rate, fixed-interest Perkins loan may land you a higher interest rate on that particular loan—or the low rate may help bring your overall interest average calculation down. Including it in your consolidation may depend on how much money you have in low-rate and fixed-interest loans.

You may also want to avoid it if your employer has a debt repayment program that only repays unconsolidated loans. If this is the case, you can choose to leave some loans out of your consolidation to allow an employer to pay them for you.

Direct Consolidation vs. Consolidation Through a Private Lender

You can consolidate your loans directly with the Federal government, or through a private lender such as a bank or credit union. If you go the government route, you get a Direct Loan from the Department of Education.

However, it’s more common to consolidate through private lenders, because most private lenders give extra perks not available through Direct Loan programs—including interest discounts for regular repayment histories or enrollment in automatic deduction programs. The loan you’ll get through a private lender is called a “FFELP” loan—it stands for “Family Federal Education Loan Program.”

Even though it’s offered through private lenders, consolidation loans are government-backed programs—and the major benefits, including fixed interest rates, will be the same no matter which lender you choose to consolidate with.

Consolidating Private Loans

You can only consolidate Federal loans through the Federal government’s Direct Loan or FFELP programs. In practice, this usually means you’re consolidating mostly Stafford and PLUS loans, which typically come with variable interest rates. You can’t consolidate your private loans along with your Federal loans, however.

If you also have private loans—and most students do—you’ll probably find these are the most problematic. Their interest rates typically vary more than Federal loans do, and are significantly higher than Federal loan interest rates—in other words, these are the loans that can benefit the most from consolidation.

You do have a few options when it comes to consolidating private loans, however. You can negotiate repayment of multiple private loans with a private lender, replacing them with a single education loan. The main benefit of this is having one monthly payment instead of several; in most cases, you probably won’t get a better interest rate and it may still be variable.

However, if your credit score has improved noticeably since the day you first took out your private loans, you may be able to renegotiate a better interest rate based on your improved credit score. In this case, it may be worth consolidating with a private lender. Your existing lender may be willing to adjust your loan terms in order to prevent you from switching to another bank or credit union.

If you own a home, you may also benefit from replacing your education loans with a fixed rate home equity loan. This would eliminate variable interest rates and may land you a better interest rate as well.

Consolidating your student loans is not a typical “yes” or “no” prospect. Discuss your situation with a financial advisor, and do the math to be sure you’re getting the best deal in all your possible consolidation scenarios. With professional advice and some research, you may be able to lower your interest rates, reduce the amount of payments you make to different lenders, and lock in a fixed rate that will save you significant money in the long run.