Should I Consolidate My Federal Student Loans?
Learn about student loan consolidation, including the pros and cons.
If you have federal student loans, you may be wondering if loan consolidation is a good idea. Often, school administrators and loan servicers push you to consolidate as soon as possible. Whether you should consolidate your federal student loans depends on a number of factors including, whether you are in default and want to get out, what types of loans you have, and whether consolidation can make your loans eligible for repayment plans that you wouldn't otherwise be able to take part in.
What Is a Consolidation Loan?
A consolidation loan is a loan which pays off all of your existing student loans, creating one single larger loan. The interest rate of the new loan is a weighted average of your prior loans.
Although it may seem counter intuitive, you can obtain a federal consolidation loan even if you have only one loan. In that sense, it is much like a refinance, but is still called a consolidation loan.
Which Loans Can Be Consolidated?
Any loan, public or private, can be consolidated. Federal loans are consolidated with a federal consolidation loan, which retains the repayment options provided by the Department of Education. (LINK). For federal consolidation loans, there is no credit requirement, and you have the right to consolidate only one time during the life of your loan.
Private loans can be consolidated, but will need to be consolidated like any other loans or debts -- applying for a loan with a private institution, obtaining credit, and doing everything else that’s required to obtain a loan from any bank. Unless the consolidation has a better interest rate or lower payments, there are no real benefits to obtaining a private consolidation loan.
Note that you cannot convert a private loan into a federal loan by consolidating. Nor can you consolidate the two together into a federal consolidation loan. This means that if you have a private loan, consolidating will not give you the benefit of federal repayment programs. And while it's possible to consolidate federal loans with a private loan, by doing so you will lose all the benefits of federal loan repayment programs, making it almost always a bad idea to consolidate federal loans into a private loan.
The Power of Consolidation
There are some very significant benefits to consolidating your federal student loans:
Getting Out of Default
One of consolidation’s most powerful features is that it will immediately bring you current on your loan in the event you are in default. It will even stave off an administrative wage garnishment should you consolidate after notice of garnishment but before the garnishment is started.
In other words, your consolidation is a “get out of jail free” card that you can use once, and only once. It is usually best kept in your back pocket until absolutely needed. This is why it is not a good idea to just consolidate immediately after school, as you will lose the ability to do so later should you have a hardship.
Getting out of default is important for many reasons, a big one being that many of the federal income-based repayment plans (where you can reduce your student loan payment if you have a low income) require that you not be in default.
Qualifying for an Income Based Repayment Plan
Consolidation also can help you qualify for flexible federal student loan repayment plans such as the Income Based Repayment (IBR) and Income Contingent Repayment (ICR) programs. These programs allow you to make payments based upon your income, and forgive remaining principle after 20 or 25 years. (To learn more about these programs, see Federal Student Loan Repayment Plans.)
Here are some ways that consolidation can affect your ability to choose a repayment plan that’s best for you:
- You can only obtain ICR with direct loans. If you have indirect loans, you can consolidate into a direct loan and then apply for ICR. (Learn the difference between direct and indirect loans in Nolo's article Federal Student Loan Repayment Plans.)
- Perkins loans are eligible for ICR, but not IBR. Because IBR is a better (and newer) program, you can consolidate your Perkins loan, and then apply for ICR.
- If you work in public service, and you have indirect loans, you will need to consolidate into a direct loan to take advantage of significant loan forgiveness programs for borrowers working for nonprofit or government organizations. (LINK)?
- Never consolidate Parent Plus loans. Parent Plus loans disqualify you from IBR, and consolidating them into your other student loans taints the entire consolidation loan, meaning you will never be able to obtain IBR. If you have a Parent Plus Loan and must consolidate, do not consolidate the Plus Loan into your other loans. Instead, leave them out of the consolidation, and pay them separately, if you want IBR.
Making the Decision to Consolidate, or Not
Whether you can benefit from student loan consolidation largely depends on what repayment program you may qualify for, and what kinds of loans you have. Start by looking up your federal loans with the National Student Loan Data System, http://www.nslds.ed.gov/nslds_SA/. You can then determine whether your loans are eligible for the repayment plan you want to use. If not, you may have to consolidate to become eligible. If your current loans are eligible for the various repayment plans you are considering, then you might want to hold off on consolidating until absolutely needed.
Beware of Companies Charging for Loan Consolidation
If you do opt to consolidate, be wary of companies that want to charge you for assisting you in consolidating. Consolidation is done by completing a form which you can obtain from your servicer or lender, and you can consolidate as a matter of right. There is no need to pay a company hundreds of dollars to assist you in consolidating your loan.