Should you consolidate or refinance your student loans?

The choice between refinancing student loans and consolidation is dependent on multiple factors. (iStock)

Consolidation and refinancing both enable you to combine multiple student loans into one big loan but the two processes work differently.

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Consolidation means taking out a Direct Consolidation Loan from the Department of Education. You can only consolidate federal loans. And while consolidation gives you more repayment options, it won't change your rate.

Refinancing involves getting a new loan from a private lender to repay private and sometimes federal loans. It can change your rate and loan terms but you lose federal certain protections if you refinance federal loans.

If you're trying to decide between a student loan refinance loan or debt consolidation, you need to understand the pros and cons of each choice.

When does it make sense to consolidate student loans?

Consolidation makes sense if your goal is to:

  • Combine multiple federal loans into one but not pay off private student loans with your new loan.
  • Gain access to extended repayment plans that allow you to repay loans for as long as 30 years.
  • Make Parent PLUS Loans eligible for an income-driven repayment plan and for Public Service Loan Forgiveness, neither of which the loans are otherwise eligible for.

You can qualify for a Direct Consolidation Loan regardless of your credit score. You'll need to apply on the Department of Education website and provide details on which federal loans you're consolidating. You can consolidate as few as one, although many borrowers consolidate several loans to streamline repayment.

WHAT HAPPENS IF YOU DEFAULT ON A STUDENT LOAN?

While consolidation enables you to lower your monthly payment by extending your repayment timeline, it won't reduce the interest rate on your loans. Your Direct Consolidation Loan will have an interest rate equal to a weighted average of all the federal debts you consolidated. And extending your repayment timeline makes total repayment costs higher because you pay interest over a longer time.

When does it make sense to refinance student loans?

Refinancing is the right choice if:

  • You want to combine multiple private loans into one loan.
  • You want to combine private and federal student loans into one new loan and don’t mind giving up the benefits of federal student loans.
  • You want to change the repayment terms of your private loans to lower your monthly payment or total loan repayment costs.

Refinance loans aren't available from the government; they only come from private lenders. Banks, credit unions, and online lenders all offer student loan refinance options but typically only to people with good credit and proof of sufficient income to repay the debt.

Refinancing is the only way to change payment terms, including your interest rate and payment timeline, on existing private loans. But it typically makes sense only if you can get a new loan at a lower rate, otherwise, your payoff could be much more expensive.

STUDENT REFINANCING RATES GOING DOWN – HERE'S WHY

If you use a private loan to repay federal student loans, you could sometimes lower your rate but you'll give up the chance at loan forgiveness and lose a lot of flexibility. While federal loans allow you to change your payment plan, chose income-driven plans, and put loans into deferment or forbearance, private lenders lock you into a repayment schedule, offer more limited forbearance, and don't forgive loans over time or for public service work.

The good news is you can still take the student loan interest deduction on a refinanced student loan, provided your income isn't too high and you meet other requirements for the deduction.

How to consolidate or refinance your loans

If you want to consolidate your student loans, simply apply with the Department of Education. To refinance, comparison shop among several different private lenders to see which offers you the best rate and terms. Shopping for a student loan refinance loan is easy online and most lenders allow you to get pre-approved and find your rates without a hard credit check so your credit score will be affected only if you actually apply for a consolidation loan.

Once you've been approved for consolidation or a refinance loan, you can concentrate on paying it off on schedule so you can free yourself of your student debt burden for good.

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