Understanding Federal Student Loan Consolidation

Federal Loan Consolidation is a process that allows borrowers to combine multiple federal education loans into one new loan, called a Direct Consolidation Loan. This can simplify repayment by creating a single monthly payment and potentially providing access to different repayment plan options. However, it's crucial to understand the advantages and disadvantages before making a decision.

What is Federal Loan Consolidation?

Federal Loan Consolidation combines multiple federal education loans into a single loan. Once the consolidation is complete, you will have a single monthly payment on the new Direct Consolidation Loan instead of multiple monthly payments on the loans you consolidated, and a smaller payment amount each month.

Benefits of Federal Loan Consolidation

Simplified Repayment: Instead of managing multiple loans with different servicers, due dates, and interest rates, you'll have a single loan and a single monthly payment. The most common reason to consolidate student loans is to group loans that might be spread across multiple loan servicers under a single loan servicer for the general convenience of the borrower.
Access to Income-Driven Repayment Plans: Consolidation can provide access to a wider array of Income-Driven Repayment Plan options. Another common reason is to transition older FFEL loans into newer Direct Consolidation loans in order to take advantage of certain federal benefits such as the Public Service Loan Forgiveness Program (PSLF).
Potential for Lower Monthly Payments: Consolidation loans often reduce the size of the monthly payment by extending the term of the loan beyond the 10-year repayment plan that is standard with federal loans. Depending on the loan amount, the term of the loan can be extended from 12 to 30 years. The reduced monthly payment may make the loan easier to repay for some borrowers.

Drawbacks of Federal Loan Consolidation

Loss of Benefits: Loan Consolidation also means the loss of all interest-free periods as well as the loss of cancellation benefits.
Increased Interest Paid Over Time: A longer repayment period means you will pay more interest over the life of the loan. By extending the term of a loan the total amount of interest paid over the lifetime of the loan is increased.
Interest Rate Rounding: Loan Consolidation will also create a new single interest rate by loan type (i.e. Subsidized or Unsubsidized) using a weighted average of the the individual loans that are consolidated together. Loan Consolidation will not lower the interest rate and it will actually be slightly rounded up during the consolidation process. If you are consolidating loans with different interest rates, the weighted average interest rate will always be in between.
Loss of Repayment Targeting: In addition, you will no longer be able to target loan repayment towards individual loans (i.e. higher interest and/or higher balance) after consolidation occurs.

Consolidation vs. Refinancing

It's important to distinguish between federal loan consolidation and loan refinancing. Loan Consolidation is different from Loan Refinancing. Borrowers can only Consolidate individual federal loans together and your new Consolidated Loan will remain as a federal loan.

Consolidation: This involves combining multiple federal loans into a single federal loan.
Refinancing: Loan Refinancing on the other hand involves transferring student loans from the federal sphere (i.e. Direct, FFEL, & Perkins Loans) and into a private financial institution. Borrowers can apply for loan refinancing with a private financial institution (bank or student loan lender), but it is ultimately the decision of that private company to take on new borrowers and to finalize the interest rate and any other terms. Refinancing has the potential to lower the interest rate of a loan, but borrowers will no longer have access to federal student loan benefits such as Loan Deferment, Loan Forbearance, Income-Driven Repayment Plans, and the Public Service Loan Forgiveness Program. After a student loan is refinanced it cannot then transition back into the federal sector in the future.

Refinancing can potentially lower your interest rate, but it means giving up federal loan benefits.

Interest Rates on Consolidation Loans

The interest rate on a consolidation loan is the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest 1/8 of a percent. That interest rate is fixed for life. If the borrower has a mix of loans with different interest rates, the weighted average will be somewhere in between.

Read also: Understanding Student Loans

Cost of Consolidation

Aside from a slight increase in the interest rate on the consolidation loan, there is no cost to consolidate your loans. There are no fees to consolidate.

Under no circumstances pay a fee in advance to get a federal education loan or consolidate your federal education loans. There are no fees to consolidate your loans.

Who is Eligible for Consolidation?

Both student and parent borrowers can consolidate their education loans. Students and parents cannot combine their loans through consolidation, since only loans from the same borrower can be consolidated. But they can consolidate their loans separately.

Students can consolidate their education loans only during the grace period or after the loans enter repayment. Loans that are in default but with satisfactory repayment arrangements may also be consolidated. Students can no longer consolidate while they are still in school. Parents, however, can consolidate PLUS loans at any time.

Which Loans Can Be Consolidated?

Any federal education loan can be consolidated. You can even consolidate a single loan. There are, however, a few restrictions on consolidating a consolidation loan.

You can consolidate a consolidation loan only once. In order to reconsolidate an existing consolidation loan, you must add loans that were not previously consolidated to the consolidation loan. You can also consolidate two consolidation loans together. But you cannot consolidate a single consolidation loan by itself.

Note that when you reconsolidate a consolidation loan, it does not relock the rates on the consolidation loan. The consolidation loan is treated as a fixed rate loan within the weighted average interest rate formula used to calculate the interest rate on the new consolidation loan.

You may consolidate Federal Stafford (bank-based) subsidized and unsubsidized loans, Federal Direct subsidized and unsubsidized loans, and Federal Perkins loans. A parent PLUS loan can be consolidated with other PLUS loans, but not with student loans.

Repayment Plans Available with Consolidation

Consolidation loans provide access to several alternate repayment plans besides standard ten-year repayment. These include extended repayment, graduated repayment, income contingent repayment (Direct Loans only) and income sensitive repayment (FFEL only). If you do not specify the repayment terms, you will receive standard ten-year repayment.

You can choose a standard, graduated, income-contingent, income-based, or if applicable, an extended repayment plan and may change repayment plans at any time. However, borrowers who are required to repay under the income-contingent plan must make three consecutive monthly payments before changing to another plan. There is no limit to the number of times you may change plans.

Repayment on a consolidation loan will begin within 60 days of disbursement of the loan, unless the borrower qualifies for a deferment or forbearance.

How to Apply for Federal Loan Consolidation

Federal loan consolidation information is available online. You can consolidate most federal education loans through StudentLoans.gov. You can apply for a federal direct consolidation loan by visiting this page.

Important Considerations Before Consolidating

Evaluate Your Goals: Are you primarily seeking a simpler repayment process, access to income-driven repayment plans, or a lower monthly payment?
Compare Interest Rates: Calculate the weighted average interest rate of your current loans and compare it to the potential rate on a consolidation loan.
Consider the Long-Term Cost: Understand that extending the repayment term will increase the total interest paid over the life of the loan.
Understand the Trade-offs: Be aware of the loss of potential benefits associated with your original loans.
Beware of Scams: Under no circumstances pay a fee in advance to get a federal education loan or consolidate your federal education loans.

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