Consolidating your student loans is similar to refinancing a loan for a car or house. The debt you once owed is now replaced by a new number at new terms. With student loans, you can consolidate them all at once or piece by piece. But new terms aren’t always beneficial, so the obvious question is, “Should I consolidate my student loans?”
Consolidating your loans is a good strategy to get out of default or lower your monthly rate. But it is not always the best strategy for getting out of debt quickly or for the least amount of money. There are many benefits to student loan consolidation, but there are also reasons to avoid it.
The majority of student loans are federal loans, but many others are from private institutions. If you have borrowed on federal loans, the process for consolidation is straightforward, as you will apply for a Direct Consolidation Loan. For those that have private student loans, you will need to find a refinancing program.
What Is Student Loan Consolidation?
If you have multiple student loans, consolidation is a way to make paying them back more convenient and lower your monthly payment. All of your loans are combined and replaced with one big consolidated loan. Instead of multiple payments each month, you are left with one big payment to a single lender each month.
Typically, a student borrower receives money from a federal loan program each semester. The issue is that there can be many different lenders sending the loans. Upon graduation, it is not uncommon to owe money to over a handful of lenders. And as each loan has its own interest rate and due date, paying them all on time can become a complicated process. The result is a higher chance of defaulting on your loan.
For federal loan borrowers, The Direct Consolidation Loan program takes all of your loans and averages out the interest rate, leaving you with one fixed rate to pay off your debt. While this method does not lower the overall amount of interest you pay, it does keep intact any federal repayment or forgiveness options.
Difference Between Consolidation and Refinancing
Those that borrowed from a private lender go through a similar process with refinancing, but there are some key differences. If you have both federal and private student loans, the only way to consolidate is through a private lender. However, if you do refinance both private and federal loans, you will lose the forgiveness programs and repayment options they offer, including forbearance and deferment.
The way refinancing works is that you go to a private bank, online lender, or credit union, and if you’re in good standing, you are likely to lower your interest rate. The lender will consider your credit score and whether or not you have a cosigner on your loan before determining what interest rate they will offer. The interest rate can be either fixed or variable, but either way, it should be lower than what you had been paying on each individual loan.
Is Consolidating Student Loans a Bad Idea?
There are three main reasons to reconsider consolidating your student loans:
- You could lose benefits. You may have to part ways with interest rate discounts you are currently receiving, potential loan forgiveness, and repayment grace period. Check the details of your loan.
- A repayment plan can cost you more over time. If you take out a Direct Consolidation Loan, you may lower your monthly payments, but you’ll pay more interest over time on a 20 to 25-year plan.
- Your overall interest rate may rise slightly. When you consolidate, a weighted average of your interest rates is calculated, but it is rounded up to the nearest eighth of a percent.
What Are the Federal Repayment Options?
There are three main repayment options available to you: Revised Pay As You Earn (REPAYE), Pay As You Earn (PAYE), and Income-Based Repayment (IBR). Knowing the difference between these programs and how they work is critical information before deciding to refinance your student loans with a private lender. So what’s the story with these options?
With each of the three programs, you put 10% of your discretionary income toward repaying your loans. This can make your loans much easier to manage if you are used to paying a larger amount of your income toward your loan repayment each month. However, there are qualifications for getting into these programs.
PAYE vs. IBR
Each program has small differences in their repayment terms. When comparing PAYE programs to IBR, PAYE has smaller payments for older borrowers, faster loan forgiveness potential, and better interest benefit. IBR is easier to qualify for, and PAYE requires that you use Direct Consolidation Loan, which is not necessarily a bad thing.
Both sets of programs will forgive your loans after 20 years, but only loans taken before 7/1/2014 are forgiven after 25 years with an IBR. Similarly, IBR requires payments totaling 15% of your discretionary income, rather than the typical 10%, if your loan was borrowed before 7/1/2014.
PAYE vs. REPAYE
Typically, PAYE programs are more beneficial for married student loan borrowers when both spouses are earning an income, while REPAYE is preferred by single borrowers. The benefit of PAYE for married couples is that your spouse’s income does not count if you file taxes separately. With REPAYE, both spouses’ income counts regardless of how you file your taxes. REPAYE also has a repayment period of 25 years, as opposed to 20 years, if you have any graduate school loans.
One of the most significant benefits that are shared by both programs is that the government pays 100% of any unpaid interest that has accrued on subsidized loans for the first three years of repayment. To qualify for the PAYE program, you must show a partial financial hardship, must not have an outstanding federal loan, and have received your loan on or after October 1, 2007. Conversely, anyone that has a federal loan is eligible for REPAYE.
Bottom Line on Student Loan Repayment Options
All three plans can be extremely helpful for borrowers struggling to make their loan payments each month. When it comes to comparing REPAYE to IBR, REPAYE is generally preferred due to its 10% repayment amount per month compared to a potential 15%. While PAYE and REPAYE are preferred to IBR, all three programs are worthy of your consideration if you are thinking of refinancing.