Clearing Up the Difference Between Federal Student Loan Consolidation & Private Refinancing

difference between federal student loan consolidation and private refinancing

Student loans do not always come with the best terms or rates as far as interest goes. If you have been contemplating between federal student loan consolidation and private student loan refinancing, it is important that you know and understand the difference between the two.

There are some pros and cons to both, so pay attention and evaluate your needs to determine which one would fit best into your lifestyle and budget. Let’s take a look below at what the key similarities and differences are.

Federal Student Loan Consolidation

Federal student loan consolidation takes your individual federal student loans and combines them into one loan. This type of consolidation does not combine both private loans and federal loans, so it is essential that you make note of this.

The purpose behind consolidation is to turn multiple payments into one single payment, so you do not have to juggle different amounts due at different dates and times. The good thing about consolidation is that there is no fee to do it and you can apply through your student loan lender.

As always, there are some requirements to consolidate your federal student loans. For starters, you need to have a minimum of one loan that is in the repayment period or grace period. Next, your loans need to be in good standing and not in default. If you do have a loan in default, it will need to be brought into good standing BEFORE it will be consolidated.

Pros of Federal Consolidation

There are quite a few pros to consolidation which include:

· Lowered monthly payments

· Single monthly payment

· Deferment and forbearance options for the loan

· Fixed interest rate

· No minimum or maximum loan amounts required to apply

· Option of repayment plans

Cons of Consolidation

· Lose any grace period you had if you consolidate during the grace period time

· It is not refinancing, so the interest rate will not be lowered

· Interest rate is weighted

As we mentioned above, the interest rate is fixed, but it is not necessarily as low as it could be. In federal student loan consolidation, the interest rate is weighted based on an average of all of your interest rates. What this means is that if you have four loans with interest rates of 5.5, 6.5, 6.8, and 5.8, then your interest rate would be 6.15 percent. While the rate is lowered than what you pay on a few of the loans, it is nowhere near what type of rate you would get if you refinanced.

Private Student Loan Refinancing

If you have the option to refinance your student loans, you may be wondering if you should or not. We covered student loan consolidation above and it differs quite a bit from refinancing, but there are some things that are the same. Often, people will interchange and confuse refinancing and consolidation. The key difference here is that refinancing works to provide you with a lower interest rate while consolidation works to combine your loans into a single loan.

The way student loan refinancing works is by creating a new loan for you. For example, if you want to refinance, you would go to a private lender and speak with them. If you are approved, the lender would pay off your current loans and then create a new loan for you with the new terms discussed.

Refinancing saves students thousands of dollars on their student loans and is beneficial for a number of different reasons. In fact, most students choose this option simply because of the lower interest rate and the option to extend, shorten, or keep the same loan repayment term.

Pros of Refinancing

· Lower monthly payments

· Option to change your repayment term length

· Lower interest rate

· Choice of fixed or variable interest rate

· Saves you thousands of dollars

· You can remove cosigners from your loans

· Usually no early pay off penalties

Cons of Refinancing

· Lose your federal benefits

· Lose any grace period or flexible payment plans you had in place

· Hard to qualify for in many cases

· Must have great credit score and history

· Can result in paying more money if you lengthen the loan term

Which One Should You Choose?

The answer to the question above comes down to you and your situation. Often times, many students choose to refinance because it saves them a lot of money, but if you do not meet the credit requirements, you will be turned away.

Student loan consolidation is a great way to save on interest payments, but your monthly amount may not always be less. Also, you must keep in mind that your interest rate is weighted and is not as low as it would be if you refinanced.


Consolidation Scenario

You have four loans that you want to consolidate. The first loan is $25,000 at 5.5% for 20 years, the second loan is $30,000 at 6.8% for 20 years, the third loan is $35,000 at 5.5% for 20 years, and the fourth loan is $30,000 at 6.2% for 20 years The total loan amount is $120,000 with a total interest amount of $86,433.26 paid at the end of the term.

If you consolidate, your new monthly payment would be $1,332.25 for 10 years with a total interest amount of $39,869.35. As you can see, consolidating your loans would save you $$46,563.91 in interest.

Refinancing Scenario

For this scenario, you start with a loan balance of $35,000 at an interest rate of 6.0% for 10 years. Upon refinancing, your loan amount and term remain the same, but your interest rate drops down to 3.5%.

Under the original loan, you were paying $388 per month and under the new loan, you will pay $346 per month. At the end of the loan repayment term, you will save a total of $5,096 in interest payments.

As you can see, the two scenarios differ, but have the same goal and that is to save you on interest payments. The right option for you will depend on your situation and what you want to accomplish.