Breaking Down Student Loan Debt Consolidation and Refinancing

Young couple reviewing loan options with a student loan financial consultantMillions of people carry the burden of paying for a college education well beyond graduation. Student loans make it possible for many to earn a degree without fronting a significant amount of cash out of their own pockets. But whether loans are funded through federal programs or private lenders, it can seem like a never-ending obligation that takes a big bite out of monthly cash flow. If you have student loans, it is important to know that you have more control than you think in managing payments and how much you repay over time. Through either student loan consolidation or refinancing, you may have an opportunity to restructure your student debt in a more affordable way.

First, Know the Difference

Student loan consolidation and refinancing are used interchangeably, but there are stark differences borrowers should understand. Consolidation is used when an individual has federal student loans while refinancing involves a private student loan lender. Someone with federal student loans can request a consolidation of multiple outstanding loans which effectively combines them into a single, new loan. The balance does not change, but the interest rate on the new loan reflects the weighted average of the previous loans’ rates. The benefits of federal student loan consolidation are numerous, including:

  • Only one bill to manage each month, as opposed to several payments and different due dates
  • Locking in a fixed interest rate instead of a variable rate which provides for predictable payments over the life of the loan
  • Lower monthly payment, although this comes with an extended repayment term which may cost more over the long run

Student loan refinancing is a similar process in that borrowers combine multiple loan balances into a new single loan. The difference is that refinancing requires securing a new loan from a private lender which involves a review of one’s credit history, score, income, and other debt obligations. Student loan refinancing may include federal student loans, private student loans, or a combination of the two. Like consolidation, refinancing has its perks, including:

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  • A lower monthly payment, but again, this may cause the borrower to pay more over time because the repayment period is extended
  • A lower interest rate that is either fixed or variable
  • Simplifying monthly payments

Both consolidation and refinancing are powerful tools for student loan borrowers who want to restructure their student loan debt, but there are a few caveats to recognize. Because consolidation uses the weighted average of previous loans’ rates, the new interest rate may not represent a reduction in the total cost of the loan over time. Similarly, refinancing may offer a lower interest rate to well-qualified borrowers, but if the rate applied for is variable, payments and the cost of the loan may actually increase. Both consolidation and refinancing have the ability to lengthen the repayment period, effectively reducing the monthly payment, but this “benefit” as mentioned above may increase the cost of the loan as more interest is paid on a longer loan term.

Which is the Best Choice?

Consolidation and refinancing are incredibly helpful for student loan borrowers who are having a difficult time managing multiple monthly payments that put pressure on cash flow. Either strategy may be used to lower what’s due each month, allowing borrowers to steer clear of student loan default while also contributing toward other financial goals. Consolidation is most appropriate for borrowers who have multiple federal student loans, given that the process does not take away any of the benefits that the Department of Education provides to federal loan borrowers. This means public loan forgiveness programs, forbearance, and deferment are all still options with a consolidated student loan.

While private lenders may be able to offer a lower aggregate interest rate, not all borrowers benefit from this choice. Refinancing federal student loans into a private student loan takes away federal program benefits, and no private lender on the market today offers similar perks to borrowers if they are facing financial hardship. Additionally, refinancing is only a smart option when the need to lower the monthly payment is pressing, or when the reduction in interest rates in noticeable (typically, more than 1% lower). Borrowers who have poor credit history or unstable income may not qualify for a private lender refinance without a cosigner, which brings in a handful of other factors to consider.

Both student loan consolidation and refinancing are viable options for certain borrowers, but each individual’s situation and need for restructuring student debt differs greatly. Make sure to understand the differences between consolidation and refinancing before pulling the trigger, and take the time to weigh the pros and cons before deciding which strategy is right for you.

Posted on September 8, 2017 by in Personal Loans, Student Loans

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