How to Consolidate & Refinance Student Loans

Student loan consolidation reminder on sticky noteIf you are a recent college graduate, chances are you’re still struggling to wrap your head around the student loan crisis sweeping America.

Here’s the gist of it:

  • Student loan debt has reached $1.59 trillion in 2019, an increase of 232% since 2006! Only mortgages top it as a source of debt for U.S. consumers.
  • Nearly 45 million Americans have student loan debt. The average amount is $33,331, which means a payment of $354 per month for the next 10 years.
  • Almost 70% of college graduates in the Class of 2018 left school with student loan debt. One in seven parents took out an average of $35,000 in Parent PLUS loans.

You may be right in assuming that the knowledge you acquired in school is priceless, but good luck convincing that to your lender, or landlord.

What makes the situation more convoluted, is that you probably didn’t just walk on to campus and sign up for one, fat $37,000 check. Most students take out multiple loans from the federal government, private lenders or both.

For instance, you may have taken out two Stafford loans a year for four years. That means when you graduate, you could be on the hook for eight different loans to eight different lenders.

Add that to the cell phone bill, car loan, rent, utilities and credit card bills you’ve got to pay every month, and even a finance major might slip up juggling so many payments.

The good news here is that there are a couple of options that allow you to consolidate your student loans into one, affordable monthly payment. You may even be able to decrease your monthly payments and pay less interest through student loan consolidation or student loan refinancing.

So, which one should you choose?

The one that’s right for you depends on a lot of factors, like whether your loans are federal or private, and how quickly you intend to repay them.

What Is Student Loan Consolidation?

Student loan consolidation is taking out a single loan large enough to pay off the balances of all your federal student loans. You make monthly payments, presumably with a lower interest rate, to repay the large loan.

Basically, the government is willing to pay off all your federal loans and give you a new loan with a fixed interest rate. And since this new loan comes from the government, it’s only possible through federal loans, meaning you can’t consolidate your private loans.

There’s a lot to be gained from consolidation, but it comes with its fair share of downsides.

Here are some of the pros and cons of student loan consolidation.

Pros of Consolidation

Student loan consolidation really makes sense if you’re working a medium-to-low-income job and don’t see that changing anytime soon.

Consolidation lets you extend the amount of time you have to repay the loan, thereby lowering your monthly payments. You can get up to 30 years to repay a loan instead of the standard 10 years.

Consolidation simplifies the student loan repayment process because you’re only writing one check a month.

It also opens the door for multiple income driven repayment plans and, if your job fits in the right category, loan forgiveness. Many of these plans will forgive the loan or a portion of it after a number of years if you work in the government (local, state or federal) or nonprofit sector. This is a good option if your career choice had more to do with the passion you have for the work, rather than the money you would earn from it.

Some of the smaller, but useful pros of consolidating student loan debt would be a re-start on deferments and forbearance; a discount if you set up automatic debit from your bank account; positive impact on your credit score if you make on-time payments.

Cons of Consolidation

For starters, you’ll likely end up paying more in interest.

If you extend the repayment term, you’ll get lower monthly payments, but that means more paid in interest over the life of the loan.

The government combines the weighted interest of the previous loans to determine the amount of interest for the new one. They round this total up to the nearest 1/8th of a percent.

This means if your weighted average comes out to 5.28%, they’ll round it up to 5.375%. If your weighted average is 5.36%, it still only gets rounded up to the nearest 1/8th of a percentage, which is 5.375%.

One last thing to consider: when you consolidate your student loans you could lose any credit you may have made towards forgiveness programs like Public Service Loan Forgiveness (PSLF) or income-driven repayment plan forgiveness.

You can pick and choose which loans to consolidate. So, if you’ve made any progress towards a loan forgiveness program you should leave those out of your new consolidated loan.

What Is Student Loan Refinancing?

Student loan refinancing is a lot like consolidation. A lender pays off your original loans and gives you a consolidated one. The main difference is that you can refinance your private loans as well as your government loans.

Your credit score is a factor in refinancing and the hoped-for result is a lower interest rate to go along with a single monthly payment.

This option can save you money if you have the income and credit score to qualify.

Here are the pros and cons of student loan refinancing.

Pros of Refinancing

Refinancing your loans can result in a lower interest rate, which is something few people will ever turn down. Some lenders offer fixed rates for as low as 3.5%.

Just like with consolidation, you have the options to extend the payment period and decrease your monthly payments, though, once again, this will end up costing you more in the long run.

Refinancing also provides an exit strategy for Mom and Dad or whoever you may have had co-sign on your student loans while still in school.

Cons of Refinancing

When you refinance your federal student loans you give up all of the safety nets associated with them. This means no forbearance or deferment, and no income-based repayment or student loan forgiveness.

Those come in hand for the 11.5% of student loan borrowers who go on to default. If you’re headed in that direction, it’d be nice to be able to put a pause on things while you plan your next move.

Instead, you’re on the hook until you repay the loan in full. Even if you were to flee the country, creditors have the right to go after your estate or cosigners to get their money back.

You should be very confident in your job security and income for the next 10 years if you plan to refinance.

Again, refinancing is not for everybody, as in, not everybody will qualify for a refinanced loan.

Private lenders are very selective when deciding who to refinance. Paying off tens of thousands of dollars in student loans is a risky investment. So, it makes sense they would want to minimize their risk as much as possible.

Generally, to qualify you’ll need a good credit score, something above 680. You’ll also need a strong and steady enough income to give them confidence in your ability to repay.

Here are some other qualifications for refinancing:

  • You have a low debt to income ratio, around 36% or below.
  • You graduated: you can’t refinance your loans if you’re still in school or if you dropped out.
  • You are an American citizen.

Should You Consolidate or Refinance Student Loans?

It’s impossible to know what your finances will look like in 10 years, but you need to ask yourself, honestly, “What will my finances look like in 10 years?”

Consolidation makes more sense if you plan to take advantage of the government forgiveness programs, or if you’ve chosen a career path with little in the way of monetary gain.

Paying more in interest is never ideal, but it’s better than defaulting on a monthly loan payment you can’t afford.

Deferment and forbearance are not tools you want to lean on too much. They come with their own sets of pros and cons, but they can be a helpful crutch for the financial rough patches in life.

Refinancing is the more attractive option because it is the one that can save you money. It should still be approached with caution, since there are no safety nets if you lose your job and your income takes a nosedive.

Still, a fixed interest rate of 3.5% is hard to pass up. If you meet all the qualifications (good credit score, low DTI, job security) you should consider refinancing.


Sources:

(2019, May 7) Consumer Credit Outstanding (Levels). Retrieved from: https://www.federalreserve.gov/releases/g19/HIST/cc_hist_memo_levels.html

Min, S. (2019, May 27). Graduating into student loan debt? Financial tips for Class of 2019. Retrieved from https://www.cbsnews.com/news/graduating-into-student-loan-debt-financial-tips-for-the-class-of-2019/

Douglas-Gabriel, D.  (2017, September 28) The number of people defaulting on federal student loans is climbing. Retrieved from: https://www.washingtonpost.com/news/grade-point/wp/2017/09/28/the-number-of-people-defaulting-on-federal-student-loans-is-climbing/?utm_term=.038094a0263b

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Griffin, R. (2018, October 17) The Student Loan Debt Crisis Is About to Get Worse. Retrieved from: https://www.bloomberg.com/news/articles/2018-10-17/the-student-loan-debt-crisis-is-about-to-get-worse