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Consolidating or Refinancing: Which is Right for You?


Today, I’m thrilled to have a guest post by Drew Cloud from The Student Loan Report, I’ll let him take it away.

Misunderstanding and misinformation abound when it comes to the differences between consolidating or refinancing student loans. Sometimes, the confusion is enough to cause you to simply avoid or put off strategies that can significantly lower your student loan payments. Not to mention simplify those payments.

Here we’ll cover what these options are, how they differ from each other, and when each is available to you. Finally, I’ll cover how to evaluate when one or the other is the right choice for your situation.

What is Student Loan Refinancing & Consolidation?

First, both consolidation and refinancing are ways for borrowers to convert their existing student loans into one new, more manageable loan. They allow borrowers to take multiple student loan payments and simplify them into just one payment a month.

What is Refinancing?

Refinancing means taking out a new loan. This loan can have different loan terms and hopefully a lower interest rate.

However, consolidation can also be seen as a part of refinancing when doing so with a private lender. Saving money on interest is another concern of borrowers (perhaps the biggest concern) and that is only accomplished by refinancing.

What is Consolidation?

The other form of consolidation – federal student loan consolidation – is done with a Direct Consolidation Loan through the Department of Education. This process results in a streamlined monthly payment. And, your new interest rate will be a weighted average of previous federal loans. Meaning your new interest rate may be higher than what some of your loans were, and lower than others.

For example, let’s say you have the following loans:

FedLoan 1 $10,000 at 5.7%

FedLoan 2 $20,000 at 7.5%

When you consolidate with a Direct Consolidation Loan you will end up with a $30,000 loan at a 6.9% interest rate.

So What Are My Options Based on What Kind of Loans I Have?

There are two broad categories of student loans. The first are federal student loans, made through the Department of Education. Private student loans are the second category, and those are loans a borrower takes out from any of a number of private lenders. These could include banks, credit unions, and other financial institutions.

Options Available ​for Federal Student Loans

Students with federal student loans can take advantage of both consolidation and refinancing. Multiple federal student loans can be consolidated into just one monthly payment by use of a Direct Consolidation Loan.

However, while a borrower keeps all of the benefits of a federal loan—including deferment and forbearance options, income-driven repayment plan availability, and forgiveness—they cannot save nearly as much on interest as they would with refinancing.

Related: What you need to know about flexible student loan repayment​

Options Available ​for Private Student Loans

While you can save lots of money in interest by refinancing private loans. Private loans are not able to be turned into a Direct Consolidation Loan, as they aren’t originally federal loans.

However, borrowers stuck with high interest rates will often discover that after graduation, when their incomes rise and they develop creditworthiness, they now qualify for refinancing. When you refinance your student loans, you can often reduce your interest rate(s) by a percentage or two at least. Those few percentage points can save you hundreds or even thousands over the life of the loan.

For example, if you have a f $10,000 with a monthly payment of $250 at an interest rate of 8.5% and you refinance to an interest rate​ of 7%. You would save $379 in interest.

I know there is a lot of crossover in terms. However, most people who talk about consolidating student loans are typically talking about the Direct Consolidation Loan program for federal loans. Whereas those talking about refinancing their loans are generally talking about using a private lender to lower the rates on federal and/or private loans.

So What Should I Do? Consolidate or Refinance?

The reason the distinction between refinancing and consolidation is so important is because federal loans can become private loans through refinancing. This is done to result in a reduction of the interest rate. However, federal loans will lose valuable loan benefits only offered to federal loan borrowers.

Private loans can be refinanced, including in such a way that multiple loans are consolidated. But can never become Federal loans and therefore can never qualify for the Direct Consolidation Loan program. 

Borrowers who took out private student loans while in school should always look into their refinancing options after graduation. In many cases, you will qualify for lower interest rates. This is because you now have a regular income and solid credit history, so it’s an easy decision to make.

What to Consider Besides the Interest Rate

Of course, there are other loan factors that are important besides the interest rate. If you do have one or more private loans and you have significant benefits, such as the availability of hardship deferral on your payments, take those into consideration. When looking for a new lender make sure they also offers those benefits.

Federal borrowers should think very carefully before refinancing their federal student loans with private lenders. The benefits available on federal loans are lost forever once they switch to private loans. Most private lenders do not offer loan deferral during periods of economic hardship, which is something available to federal borrowers.

Moreover, federal loans are eligible for many income-driven repayment options that are offered by the Department of Education. Under these plans, a borrower’s monthly payment can be significantly reduced, down to as low as $0 a month. Since these benefits are not available with private lenders, most federal borrowers choose to keep their loans with the Department of Education. 

Related: Paying Off Student Loans – The Best Approach

Drew Cloud is the founder of the Student Loan Report. After struggling to repay his own student loans, he decided to launch his site to help keep borrowers up-to-date on the current student loan news. Aside from starting this site, Drew is a freelance writer who typically talks about student loans, personal finance, and education. 

If you’re interested in guest posting on Less Debt More Wine, please read my guest posting policy.

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One Comment

  1. I’ve run into issues while looking into consolidation. I’ve only been offered loans with variable interest rates (which I’m not keen on) even though I have excellent credit. I also did the math and determined that if I snowball my loans (I have six), I’d be able to pay them off faster than consolidating. Even though my current monthly payments suck.

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