Most students go to college with a vision of bright future ahead. But a lot of students are also burdened with gigantic student debts with steep monthly payments which greatly affect how they achieve that financial future they dream of.
Consolidating or refinancing student loans could be a solution for this. But how do these two options differ and which one is the best choice for you?
When talking about student loans, refinancing and consolidating are two terms that you would hear a lot. Although the two terms have different meanings, there is something common between them – to make it easier to pay for student loans by combining several different loans into a single monthly payment. The biggest difference between the two is what they can do for you. By refinancing your student loans, you get a lower interest rate on private and federal student loans. Consolidating your loans meanwhile gives you better control of your federal student loans.
| REFINANCING | CONSOLIDATION | |
| Goal | Your private and federal loans have high-interest rates and you want to save some money | You want to simplify the payment process for multiple federal loans while also maintaining the benefits they offer |
| Offered by | Private lenders such as credit unions and banks | Federal government |
| Eligible Loans | Private and federal student loans | Only federal loans are eligible |
| Pros | 1. Single monthly payment for multiple private and federal student loans
2. Lower interest rates and lower monthly payments 3. Variable interest rates can be converted to a fixed rate for predictable payments every month 4. Decreased loan term for faster repayment | 1. Single monthly payment for one loan
2. Get predictable monthly payments by converting variable rate to fixed rate 3. Lower monthly payments with increased loan term 4. Benefit from federal loan protection such as loan forgiveness and income-based repayment. |
| Cons | 1. No federal loan protection | 1. Private student loans are not eligible
2. No reduction of interest rate |
| Federal Loan Benefits | Federal loan benefits are removed | Maintained federal loan benefits |
| Interest Rate | Rate is calculated based on the credit score of the borrower or cosigner | Rate is calculated using the weighted average of all your federal loans rounded up to the nearest ⅛ percent |
Going to college without full scholarship to pay for the expenses means you have applied for a combination of private and federal loans. The terms, interest rates, and balances for each loan will vary. Some student loans would have fixed rates while others have variable rates. Student loan refinancing combines all your private and federal student loans into one loan that could have better terms and rates especially if you have a good credit score. You can only do refinancing with a private lender.
Refinancing offers benefits such as:
• Faster repayment – The lower interest rate allows you to get s shorter term loan so you can pay of your student loans faster without the need to increase monthly payments.
• Lower monthly payment – With lower rates come lower monthly bills and more cash for you to set aside. You can also save more money on the interest you pay for the lifetime of the student loan.
• Fixed monthly payment – If some of your education loans have variable instead of fixed interest rates, you’ll see them increase every time the rates increase which leads to higher monthly payments. Refinancing will give you the chance to change these variable loans into a fixed-rate loan so you pay the same amount every month.
• Longer terms – You can extend the term of a loan to 15 or 20 years from the standard 10-year repayment period. However, this would also mean that you are paying more on interest as the loan term gets longer.
• Ease of payment – Refinancing your student loans means you only need to make one, often lower, monthly payment.
If you want to maintain the benefits and protection of your federal student loans, your best option is to consolidate them. Loan consolidation means combining your federal student loans into one loan form the federal government. One thing to consider is that private loans are not allowed to be consolidated.
Another major difference between refinancing and consolidating is the interest rate. Loan consolidation will get you a fixed interest rate but it will not be lower. Instead, what happens is that the loan provider takes the weighted average of the interest rates of all your active federal loans and round this up to the nearest ⅛ percent.
For example, you currently have six federal loans. Three of the loans have a 7% interest while the other three have 5% interest. The weighted average of these interest rates when you get a consolidated loan is 6%. This leads to three of the loans getting an interest rate increase while the other three would get a decrease. The result is a single consolidated loan with a 6% interest.
Although loan consolidation doesn’t automatically give you some savings, there are still great advantages when you consolidate your loans.
• Fixed monthly payment – If your loans have variable rates, consolidating these loans gives you the benefit of a fixed rate which also means fixed payments every month and the knowledge that your monthly payments will not fluctuate.
• Easier payment – You only need to keep up with one loan and pay for it every month which will cover all your federal loans.
• Longer terms with lower monthly payments – You will not get a lower interest rate but you can choose to have a longer loan term which will allow you to make lower monthly payments. However, remember that a longer term means you pay more in interest during the lifetime of the loan.
With loan consolidation, you get to keep the protection benefits of federal loans such as loan forgiveness and income-based repayment terms. If you anticipate a decrease in your income or are planning to enter a career eligible for loan forgiveness, consolidation offers you more advantages.
If your goal is to save money on your loan payments, refinancing is your best choice. But if you want to maintain the federal loan benefits, consolidation is the answer. The best option for you would depend on several different factors such as your income, creditworthiness, goals, the types of loans, the interest rates, and if you need federal benefits.
