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Ultimate Guide to Private vs. Federal Student Loan Consolidation: Perks & Pitfalls

Last updated 03/15/2024 by

Heather Skyler
According to the Federal Reserve Bank of New York, student loan borrowers in the U.S. were $1.3 trillion in debt at the end of 2016. This marks an increase of 170% from 2006.
The reason? Key factors include the fact that more students are taking out loans, bigger loans are being taken out, and borrowers aren’t paying them off as quickly.
If you’re one of these borrowers and have more than one student loan, you might consider consolidating the loans. Consolidation makes it easier to keep track of your loan since ther will only be one payment.
There are two types of loan consolidation: federal and private. Each one is done for different reasons. Let’s take a look at what’s involved and the perks and pitfalls of each.

Federal student loan consolidation

Federal student loan consolidation combines all of your federal loans into one loan, which simplifies your monthly payments. The process is free, so if a company tries to charge you for a federal consolidation, they are trying to scam you— don’t do it.
Kevin Walker, head of Education Loans at LendingTree lists some of the benefits: “Federal consolidation can result in a lower monthly payment by extending repayment length. Federal consolidation preserves most of the (very) flexible repayment options available on federal loan programs for deferment, forbearance, and income-based repayment.”

How does federal student loan consolidation work?

Federal student loan consolidation is done through a Direct Consolidation Loan offered by the Department of Education. It can only be used for federal loans, not private student loans. Your original loans will be marked as paid off and closed for good.
Your new fixed interest rate will be the weighted average of the interest rates on your original loans, rounded up to the nearest one-eighth of a percent. So, consolidating your federal loans will not help you save on interest. In fact, it could result in even higher interest.
So if you’re looking to save money, this isn’t your best option. It can, however, qualify you for an extended repayment period, which can lower your monthly payment amount. But be careful because you could end up paying more in interest over the life of the loan when you extend your repayment period.
You are eligible for federal student loan consolidation if you are out of college or attending classes less than half-time. Loans that are in repayment or the grace period are eligible for consolidation.
Loans that have been in default are eligible after you’ve made three consistent monthly payments or if you agree to repay the consolidated loan under an income-driven repayment plan.

Federal programs: benefits and risks when consolidating

Federal loan consolidation could make you eligible for federal programs that your current federal loans aren’t eligible for, such as income-driven repayment plans and loan forgiveness. These beneficial perks could make things a lot easier for you. But you need to be careful.

Proceed with caution

As helpful as these options may be, they could also turn into the opposite and become an expensive trap. That’s because loans forgiven under an income-driven repayment plan are considered taxable income, and that could end up costing you more than your budget will allow for.
Teacher loans and public service loans are the only federal loans that are safe from being taxed.
Also, if you choose to consolidate your loans, you can lose your progress with student loan forgiveness. To qualify for forgiveness, you have to work full-time for a qualifying employer and make 120 qualifying monthly payments on your loan.
You’ll have to start over if you consolidate your loans. So, you may want to hold off if you’re working towards forgiveness.

PLUS Loans come with a new set of rules

You also have to be careful how you consolidate your federal loans. PLUS Loans don’t offer the same repayment plans as other Direct Loans. So, if you consolidate the two together, you’ll lose access to income-driven repayment plans and the forgiveness programs that come with those Direct Loans.
The good news is that there’s a unique solution to this problem, which you can read about here.

Deferment and forbearance

A particularly beneficial perk of federal loans is the option for deferment and forbearance. If you face a hardship that prevents you from making on-time payments (i.e., job loss or serious illness), you can temporarily stop making payments for a period without defaulting on your loan.
This is important because defaulting on a federal loan isn’t the same as defaulting on a private loan. The federal government can garnish your wages and use your tax refund to repay the loans that have gone into default.
Here is a list of the benefits and the drawbacks to consider.
  • Easier to manage payments (one monthly payment)
  • Various repayment plans and forgiveness programs
  • Could get a lower monthly payment
  • Deferment and forbearance
  • Helps avoid default
  • Fixed interest rate
  • Won’t save money
  • Could have a higher interest rate
  • Extended repayment period could result in more interest charged over the life of the loan
  • You’ll lose progress with student loan forgiveness
  • Can only be used with federal loans
  • Debt forgiveness is taxable
  • Consequences of defaulting are extreme

Private student loan consolidation

Private student loan consolidation can also be called to as “refinancing.” That’s because consolidating with a private loan results in a new loan with a different term and interest rate than the old loans.
As mentioned above, the interest on a federal consolidation loan is equal to the weighted average of the loans being consolidated. That’s why federal consolidation isn’t considered “refinancing” the way private consolidation is.
That being said, the primary goal of private refinancing is to get a lower interest rate and, therefore, a lower monthly payment. It allows you to combine ALL of your loans– both federal and private– into one.
This gives you various options to create an affordable payment plan.

How does it work?

Student loan refinancing is done through a private lender, who issues you a new loan to pay off the old loans. Unlike federal student loan consolidation, you can choose between a fixed or variable interest rate.
As with any private loan, your rate will be based on a variety of factors including your credit score, income, job history, and educational background. The best rates are typically reserved for those with good to excellent credit.
However, if you can’t get approved on your own, you can have a cosigner help you. And to give you and your cosigner a little peace of mind, many student loan refinancing lenders offer a cosigner release option.
In other words, after a specified amount of on-time payments have been made, the cosigner can be removed from the loan.

Refinancing federal loans

Consolidate your federal loans into a private loan and you will lose your federal loan benefits. You won’t have access to deferment and forbearance options. You also won’t have the same loan forgiveness options that federal loans offer. But there are alternatives, which you can read about here.
Here is a list of the perks and pitfalls to consider when consolidating student loans.
  • Can consolidate both private and federal loans
  • Easier to manage payments having only one loan
  • Several options to create an affordable repayment plan
  • Lower interest rate
  • Cosigner options
  • Must have good credit
  • Lose federal loan perks
  • Additional fees (many lenders charge an origination fee)
  • Variable interest rate could increase future payments
  • Some lenders require a college degree and have debt-to-income and minimum annual income requirements

The process of student loan consolidation

Walker says the process of consolidating student loans can be a fairly intensive process. “You’ll have to provide details on which loans you want to include in the transaction. Some lenders can help you find this data, but it helps if you have the details available when you start the process. You MUST remember to continue making payments on your original loans until the consolidation or refinancing is complete.”

Federal consolidation

If you’re interested in federal consolidation, visit the U.S. Department of Education to access an application and begin the process. You can fill out and submit the application online, or print it out and mail a copy.
Once you’ve submitted your application, the consolidation servicer will consolidate your eligible loans and will be your point of contact for all questions about the process. According to Walker, the process for federal consolidation typically takes 60-90 days.
Again, it’s important to keep making payments on your current loans until you’ve been informed that you have a new consolidated loan.

Private consolidation

If you’re seeking private consolidation, there are several options.
Remember to payoff your debts before the end of 0% interest period. High interest rates after bite at your savings.”
Walkers says, “There are many student loan refinance lenders on the market. Each lender has multiple variations on refinancing offers: multiple years for repayment, fixed vs. variable, co-signed vs. non-co-signed. It’s important to shop around and do your homework before committing to a particular lender.”
He adds that refinancing can be faster than federal consolidation and usually takes 15-45 days.
To get started, check out SuperMoney’s loan offer engine to get pre-approved, personalized offers from leading lenders. This will not hurt your credit.

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Heather Skyler

Heather Skyler writes about business, finance, family life and more. Her work has appeared in numerous publications, including the New York Times, Newsweek, Catapult, The Rumpus, BizFluent, Career Trend and more. She lives in Athens, Georgia with her husband, son, and daughter.

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