Understanding Student Loan Consolidation

Understanding Student Loan Consolidation.jpg

Student loans are wonderful and horrible tools that allow people who can't afford an education to pay for one by simply mortgaging their future. If you're one of the unlucky and you've been avoiding doing the leg work and mental work in understanding your consolidation options, this is for you. If you are one of the lucky ones to graduate relatively unscathed by these monsters, I know you have friends who weren't so lucky. Make their day and forward this along.


Federal Loans vs. Private Loans: Know The Difference

There are two types of student loan consolidation: federal and private. It's important to understand the difference because their processes and outcomes are different. 

Federal student loan consolidation might not lower your interest rate or save you money. In order to be eligible for some federal loan repayment programs, you may need to consolidate the debt. Consolidation is a logistical move that's done through the Department of Education. And this type of consolidation is only available to Federal loans.

Private student loan consolidation is done through a private lender, not the Department of Education. The term private means a company that exists to make a profit. This type of consolidation is loan refinancing. Most of the time, this type of refinancing is done because you can potentially save money by getting a lower interest. The lower interest rate is based on factors like your credit score and income.  Both private and federal loans may be refinanced


Federal Student Loan Consolidation 101

  • Consolidating your federal loans is free through the Department of Education; you don't need to pay a company to do this for you. 
  • You cannot undo consolidation.
  • Through the consolidation process, the government will pay off your loans and you'll then be responsible for paying back a direct consolidation loan. 
  • You are generally eligible once you graduate, leave school or drop below half-time enrollment.
  • The new, fixed interest rate for your consolidated loan is a function of the previous interest rates. It is the weighted average of your previous rates. A weighted average is a way to calculate your interest rate where some rates have a greater influence than others. If you're having trouble wrapping your head around WTF a weighted average is, there is a second part of the equation to make it more confusing. The weighted average interest rate is rounded up to the next 1/8 of 1%. Don't worry, you don't have to do the math. Check out this weighted average interest rate calculator from our friends over at Student Loan Hero.
  • After you consolidate, you'll get a new loan term. The terms are usually between 10 and 30 years. Most of the time, your first payment will be due within 60 days of when you consolidate.



How to Consolidate Federal Student Loans

Well, I'm glad you asked.


1. Gather all of your current student loan details. 

Get your shit together. Get it all together. Get your most recent statements, make sure you can log into the loans. You might want to even put the details (like the amount still due, the interest rate and term) in a spreadsheet so you have it handy when it comes time to start analyzing. 


2. Research and choose a federal loan servicer

These are companies that manage federal loans on behalf of the Department of Education. The big four servicers are  FedLoan Servicing, Great Lakes Educational Loan Services Inc., Navient and Nelnet. If you're already with one of the top four, you can stay with them or choose a different provider.


3. Research and choose a repayment plan.

It's called a repayment plan because it's the plan for how you'll make monthly payments to repay the loan. There is a standard repayment plan for direct consolidation loans, you will make equal payments for 10 to 30 years. There are six other payments plans you can choose from. And within that are four-different types of income-driven repayment plans. A lot to sort through, I know.

The easiest way to determine what works best for you is to use a calculator to see exactly what the monthly payment is for each type of payment plan. Find out what repayment plan makes sense for you in terms of what you can afford each month. 

Don't be afraid to take your time here. Here's the thing about choosing a repayment plan: you have to balance different factors like whether or not you'll be eligible for a certain type of repayment plan and how it impacts your monthly payment. 


4. Set aside some time to complete your application.

Completing your application online like getting tickets on Ticketmaster. You have to complete it in a single session. 

Got to studentloans.gov and get logged in with your Federal Student Aid ID. Under the repayment and consolidation tab, choose “Complete a Consolidation Loan Application and Promissory Note”.

Select the federal loans you would like to consolidate. If you have a PLUS or Perkins loan, you might want to consider not consolidating these loans because you'll lose benefits that are specific to these loans. 

Select the repayment plan. If you plan to choose an income-driven repayment plan, they'll ask you for details on your last tax return. The easiest way to get this to the servicer is to give them permission to access your IRS tax data. If you choose to opt out of this, you'll need to submit a copy of your most recent federal tax returns directly to the loan servicer upon completing the application.


5. Complete and submit your application.

After you submit your application and before it's processed, you still need to be responsible and pay your current student loans. If you need to ask questions or report any issues, you can call Federal Student Aid’s Loan Consolidation Information Call Center at 1-800-557-7392.


When Should You Consider Federal Student Loan Consolidation?


1. In order to have access to repayment plans and forgiveness programs

You might not be eligible for Pay as You Earn, Revised Pay as You Earn, and income-contingent repayment plans or Public Service Loan Forgiveness without consolidation or if your loans are not federal loans in the Direct Loan Program. Only federal loans in the Direct Loan Program eligible for these specific programs.

If you're not sure whether or not you need to consolidate in order to be eligible, you have to do your research. Call the current loan servicer and ask someone to explain it to you.


2. To experience the life-changing magic of tidying your finances

Consolidating streamlines your student loans. You no longer have multiple loans with multiple due dates and multiple monthly payments. If that sounds awesome to you, it might be worth consolidating, especially if you're missing payments and paying late fees and/or more interest because you can't get it together. 


3. To see the light at the end of the default tunnel

If you miss a payment on your student loans, that's when your loan goes into default. If you consolidate a loan that is in default, you will magically now restore your eligibility for federal loan benefits. Here are some of the benefits: deferment, forbearance and loan forgiveness programs. 

There is a rub. If you are consolidating as a means to get out of the vicious default cycle, you'll need to prove to the lender that you're serious by demonstrating one of the following: you must choose an income-driven repayment plan or make three consecutive, on-time full monthly payments before you consolidate. That makes sense right? The servicers want you to pay on time because that means they get paid, but if you haven't historically been on time with your payments, they need you to demonstrate why they can trust that you'll make payments on time going forward. You need to help them help you.


When You Should NOT Consider Federal Student Loan Consolidation


1. If you'll lose access to loan benefits like repayment plans and forgiveness programs

Take the Perkins loan for instance. A Perkins loan has a loan cancellation benefit. If you consolidate the loan, you will lose the benefit. Remember the reason is because the old loans get paid off and then you get new loans. So the new loan is under the terms of the new loan service provider. 

Another great example is if you have a parent PLUS loan in addition to other federal loans. The parent PLUS loan is ineligible for income-based repayment plans. So if you roll the parent PLUS loan in with the other federal loans, you'll be totally ineligible to participate in any income-based repayment plans. If you really need an income-based repayment plan, this is a bitch of a mistake to make.  


2. If paying more interest will really harsh your mellow

There is a really good chance you'll end up paying more interest when you consolidate. It's the price you are paying for the potential benefits.

There are three scenarios that may increase your interest rate. The first one is a result of extending your repayment term. Let's say you have paid for five years on loans that are 10 year terms. You consolidate and the new terms is 10 years. So instead of just paying the remaining five years of the original term, you've extended it by five years. You might do this because it lowers your monthly payment. Even if the consolidated loan lowers monthly payment, you'll likely pay more interest over the entire life of your loan. 

The second way is that your interest rate could be slightly higher. Remember: your new interest rate is the weighted average of all the rates and gets rounded up to the nearest 1/8 of 1%. Because that's a totally normal way to calculate things. Could you imagine going to Nordstrom's half yearly sale and a sales associate offering you two pairs of shoes, both on sale at a discount, but the new sale deal they want to give you is the weighted average discount rounded down to the nearest 1/8 of 1%. Fuck no. And this is a great illustration of what's fucked up about our financial system.

The third way you end up paying more interest is if you have accrued interest on the loan and haven't paid it. That interest gets wrapped up in the new consolidated loan as part of the principal balance. And you pay interest on the principal balance. So it's like they loan servicers are double dipping on you, playing you like a damn fool. But if having one payment will keep you on track and you can afford it, then it might be worth being played like a damn fool. 


3. If hitting reset on all the work you've done towards loan forgiveness is a deal breaker

Loan forgiveness is a beautiful unicorn. It's possible, but I haven't met anyone who has had this happen. Although that could just be a function of the people I know and not a true reflection of its prevalence.

You have to meet certain requirements in order to have your loans forgiven. One way is through the Public Service Loan Forgiveness Program. In order to be eligible for this, you must make 120 full loan payments while you are working for a nonprofit or the government. Just a cool 10 years of payments. NBD.

But if you consolidate, those payments you made vanish into the ether like bitcoins being used on the dark web. You'll hit restart on the 120 full loan payments needed to be eligible. If you're close to this, it might not make sense for you to consolidate. 


Private Loan Consolidation 101

Private loan consolidation is when you refinance your student loans with a private lender. You can consolidate your federal loans and your private loans. But remember, when you consolidate your federal loans with a private lender, what happen is the private lender pays off your Federal loan and now you have a new loan with the private lender. So you'll no longer have access to federal programs and benefits because the Department of Education isn't in charge of your loan anymore.

It would be like if your rich grandmother paid off all of your student loans and now you owe money to the bank of grandma. The bank of grandma has her own terms and loan programs. Loan forgiveness is not one of those programs the bank of grandma offers. See how the owner of your loan changes and how the programs that were once available are now not?

One of the big benefits of refinancing is the chance lower interest rate or pay off your student loans faster with a private loan. I'm sure you're shocked to learn that the private sector can be more competitive when offering a finance product to consumers. Just kidding, it's not shocking at all.

However, your credit score, income, educational history and job history will all be factors that a private lender are things that will be reviewed when a private lender considers offering you refinancing. If you don't have proof of income because you're a freelancer who doesn't get a pay stub, it might be harder for you to get refinancing.

As a general rule of thumb, you'll want to have a credit score of around mid-600 in order to get offered a good interest rate. The rates for refinancing float between 2% and sometimes higher than 9%. One thing to consider again is to make sure that the monthly payment is something you can afford.


Be Discerning

Make sure you consider all of the ways consolidating can impact your life. Can you afford the new monthly payment? Will you lose access or gain access to certain programs or benefits? If you make a decision about consolidating without first running the numbers you are flying blind and you are taking a big risk.

Hey freelancer and/or small business owner, I'm talking to you. Can you afford to make a fixed monthly payment if you consolidate your loans with a private lender or do you really need to be on that income-based repayment plan? 

I'm sorry that our financial sector preys on students who don't know much about how student loans work. I'm sorry there is so much personal responsibility and opacity in and around something that can totally ruin your life. It totally sucks, but all we can do is get armed with knowledge, fight the good fight and breathe.