College students can take out new loans each year they’re in school, so by the time graduation comes, it’s common to have half a dozen, or more, individual loans. Each of them may have different terms, including interest rates.
Consolidating those loans into a single new one can simplify your payments, especially if your loans are with different loan servicers, the companies that oversee your payments. It can also be a way to get into repayment plans you otherwise wouldn’t be eligible for.
But that doesn’t mean consolidation is always a smart move. Here are four things to consider before you make the leap.
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1. Consolidation won’t save you money.
One of the myths of consolidation is that it makes your debt less expensive by lowering your interest rate. Historically, that may have been accurate, since consolidation was often used as a way to lock in a low interest rate on variable-rate loans, says financial aid expert Mark Kantrowitz. But that hasn’t been the case for the past decade, since the government stopped issuing student loans with variable rates.
If you consolidate your loans now, your new rate will be based on a weighted average of all your loans’ interest rates. So, for a simplified example, if you have two loans, one for $10,000 at 4% interest and one for $5,000 at 6%, your consolidated loan will have a $15,000 balance and a 4.7% interest rate.
By combining your interest rates, you also lose the ability to employ a favorite tactic of financial planners for paying down debt: targeting the most expensive debt, the loan with the highest interest rate, first.
What’s more, consolidation typically results in the borrower paying more in total interest because consolidated loans are generally stretched out over a longer period, says Jessica Ferastoaru, a student loan counselor with Take Charge America.
2. Consolidation usually gives you more repayment options, but it can limit them too.
Consolidation is often the first step borrowers must take to enroll in some of the government’s more flexible repayment plans, including income-driven plans, many of which are restricted to borrowers with Direct Loans.
Borrowers who graduated before 2010, when the government shifted to Direct Loans, for example, need to consolidate their loans to access the latest income-driven plan, Revised Pay As You Earn. Parent PLUS borrowers most consolidate their loans into the federal Direct Loan program if they want to enroll in the only earnings-based plan available to them, income-contingent repayment.
Consolidation also opens up the door to extended repayment plans, in which your term can stretch up to 30 years depending on how much debt you have.
Consolidation doesn’t always work to your benefit, however. For example, if you have Parent PLUS loans for a child and individual loans that you took out for your own education, you shouldn’t consolidate them, says Adam Minsky, a lawyer in Boston who specializes in student debt. That’s because Parent PLUS loans are not eligible for several types of income-driven repayment, and they carry that restriction with them in a consolidation, causing your student loans to lose those options, as well.
3. Consolidation can affect your eligibility for forgiveness.
Be wary of consolidating if you’ve already made progress toward loan forgiveness under the 10-year period for public sector employees or the 20-year period under income-driven plans. Consolidating starts that clock over, so if you’ve been in an income-based repayment plan for five years and plan to stay in that plan until you hit forgiveness in another two decades, it’s not generally worth it to consolidate.
4. Federal consolidation and private refinancing are very different.
Borrowers sometimes use the terms “consolidate” and “refinance” interchangeably when talking about their federal loans. But they’re actually very different concepts. You can consolidate but not refinance your federal loans within the federal system—to refinance, you have to go to a private lender.
Consumer advocates caution that there’s a serious downside to moving to a private lender, even though you might get a slightly lower interest rate. Once you leave the federal program, you can’t return and are no longer eligible for one of its income-driven repayment plans.
Private consolidation is a completely different story, though. In that instance you’re essentially finding a private lender that will refinance your private loans. If you have private debt and you’re offered a lower rate and better terms through refinancing with a reputable lender, that’s worth pursuing.