So you’ve come to the point where you have too many loans and you’re paying five, six, seven, or in my case 15, different loans at the same time. It’s enough to make your head spin, and combining all those accounts would be such a relief, especially when some of those loans qualify for some kind of federal, income-based repayment program, and some do not. Can you imagine the surprise a student would get when a collection notice shows up in the mail because he has a loan that isn’t covered by his repayment plan, though he thought it was?
Students with multiple student loans have two consolidation options: (1) federal direct student loan consolidation and (2) private student loan consolidation. Each option has some value to it, and any student intending to consolidate her student loans should look at each one.
Federal Direct Consolidation Loan
Students generally consolidate with the Federal Direct program for any of a few reasons. First, the loan is easy to qualify for. Second, students are able to consolidate their student loans into one or two loans. Third, if students have loans that aren’t eligible for one of the government’s various income-based repayment programs, consolidating their loans solve that problem.
The Federal Direct Consolidation Loan program allows any student, regardless of his earning capacity, credit history, or credit score, to consolidate all of his existing student loans into either one or two loans. Generally speaking, every federal student loan is eligible to be consolidated except for the Parent PLUS loan. This would include loans like Stafford, Perkins, Direct Plus and Supplemental loans. Private student loans cannot be consolidated with a Federal Direct Consolidation Loan.
Students and graduates will receive one loan if they only had graduate or undergraduate loans. If an applying student has both graduate and undergraduate loans, then he or she will end up with two consolidated loans. The first loan consolidates all their undergraduate loans, while the second one consolidates all their graduate school loans. This happens because of the way the interest rates are calculated.
Since the Direct Consolidation Loan program doesn’t take a student’s credit score and history into account, the interest rate is calculated differently than other loans. Instead, the new interest rate is based on the weighted average of all your other student loans, and then rounded up to the nearest 1/8 of a percent. And, while all consolidation loans applied for before July 1, 2013 are capped at 8.25%, the federal government removed this cap for all consolidation loans applied for after that date. This slight increase in interest rate, coupled with a much longer repayment term, does mean that students will be paying much more in interest for the life of the loan.
Along with the ability for students to make payments based on their income, the Federal Direct Consolidation Loan program extends the length of the loan from 10 years to 20 or 25 years, depending on which repayment plan is picked. This has the added benefit of increasing the borrower’s cash flow, as the loan payments are significantly less per month than they were under the 10 year plan. These loans also come with some other protections as well, and, while some private lenders do offer these protections, most do not.
Some of these protections include deferment and forbearance. Deferment allows the borrower to suspend his payments when he is serving in active military, attending more school, such as graduate school, or even unemployment. Forbearance, allows borrowers to postpone payments while still accruing interest, in cases of financial hardship.
Private Consolidation Loan
Students may consider applying for a private consolidation loan for reasons similar to those looking at the federal version. However, there are some key differences between the two types. Perhaps the biggest difference is that private lenders, for the most part, consider the credit of the borrower. This means, in many cases, that potential borrowers need to have a cosigner in order to qualify for the loan, because they lack any substantial credit history.
Even with a cosigner, getting a private consolidation loan gives students who qualify the ability to save thousands of dollars over the life of their loans, when compared to their federal counterpart. Many times the interest rates are much lower.
In addition to these savings, students will find that they can, in some cases, combine their federal and private student loans, something that cannot be done with the Federal Direct Consolidation loan. Combining federal and private loans does cause the borrower to lose her federal protections, such as deferment and forbearance, some of these private lenders also provide the ability to defer, or significantly lower monthly payments when the borrower is dealing with personal financial issues. On top of that, many times private lenders will release cosigners from the loan after the student makes the required number of payments.
Finally, the length of private consolidation loans is capped at 20 years, while many institutions only offer up to 15 years. So, while you are paying more each month, because of the shorter length, keep in mind that you are also going to be paying thousands of dollars less over the length of the loan.
Bringing it all Together
While both federal and private consolidation loans offer potential borrowers a way to simplify their payments, if that is the only reason they are considering consolidation, they should think twice. Remember, if the terms in the new loan are not going to be better than the current terms, consolidation is not a good idea. On the other hand, if a student is struggling to make payments, or wants a lower interest rate, she should seriously consider getting a consolidation loan. If you are looking to consolidate, make sure you look at your situation carefully, and pick the loan that best fits your long-term goals.