Refinancing vs. Consolidation and What It Means For Your Student Loans

If you’ve taken on student loans in recent years, then you’ve likely asked yourself if you should refinance or consolidate the loans, or perhaps not do anything. These are normal questions as you’re managing your student loan debt.
And with federal student loan relief measures extended by President Biden until September 2021, now is a natural time to wonder if you need to make any changes to your loans.
Whether you have federal or private loans, you need a firm understanding of what refinancing versus consolidation really is before you make any changes to your student loans.

Refinancing your student loans

Refinancing simply means replacing your existing loan (or loans) with a new one, with new payment terms. You can use your current lender or find a new one altogether. When you refinance, your existing loans are paid off, your loan balance is transferred, and you enter into a new contract for payment.
You can roll one, two, or multiple student loans into a single loan.
Refinancing could be a beneficial option if you have multiple student loans and lock in a lower interest rate. But if you go the route of refinancing, you need to understand the number of years of your new terms and the new interest rate, in addition to your new monthly payment.

The benefits of refinancing student loans

The reason why refinancing is a popular financial tool is because of the potential benefits of new loan terms, including:
  • Potential lower interest rate. Depending on your new loan terms, your new interest rate may be lower. This means less money paid towards interest over the life of the loan, potentially saving you money over the years.
  • Longer time for repayment. If you stretch your payments over additional months versus your old loan, then it may provide additional relief in your monthly budget with lower payments. The only downside to this is you’re potentially paying more for interest over time.
  • Remove a co-signer. If you have a co-signer on your student loan currently, you can get the co-signer removed by refinancing.
  • New lender, new relationship. Refinancing allows you to choose a new private loan lender, which in turn may result in better customer service or an improved relationship with your lending institution.
  • Simplified payment process. If you’re refinancing several loans, by combining the loans into one new loan, you’re simplifying monthly payments and making your life a tad bit easier.
But before you sign up for refinancing based on these benefits, it’s important to understand the difference between refinancing private loans and federal loans.

Private student loans and refinancing

When it comes to student loans, you either have federal, private, or a combination of both. Of course, you can also have personal loans you use for educational purposes, but let’s focus on federal and private for now.
A private student loan is one you secured from a lender that is not the federal government.
It could be from a bank or credit union for instance.
Private loan lenders set the interest rates based on the average market interest rates and the London Interbank Offered Rate (LIBOR). And while in the past private student loans had higher interest rates than federal loans typically, the interest rates are now becoming more competitive.
The interest rates for private loans are based on a number of factors, including your creditworthiness. The interest rates are also fixed or variable, depending on the type of loan you secure. You typically finance private loans for five to twenty years.
You can refinance a federal or a private loan into a new private loan. But keep in mind, you can never convert a private loan into a federal one.

Federal loans and refinancing

A federal student loan is simply a loan made by the government for education purposes.
The interest rates from federal loans are determined each year by Congress. Federal loans do have a fixed interest rate unless there is a change in rates set by the government. And unlike a credit card or personal loan, the interest rates are usually lower and quite competitive.
Depending on the repayment program you choose for your federal loans, you’ll have access to longer repayment terms too.

Subsidized loans

Federal loans fall into the subsidized or unsubsidized category.
Direct Subsidized Loans are for undergraduate students who demonstrate financial need. The U.S. Department of Education pays the interest while you’re enrolled in school, a forbearance, a deferment, or a grace period.

Unsubsidized loans

Unsubsidized loans are available to both undergraduate and graduate students and there is no requirement to demonstrate financial need. You’re responsible for paying the interest at all times during your repayment period and it accrues while you are in school, deferment, forbearance, and any other grace period.
As you’re facing decisions about refinancing, knowing if your federal loans are subsidized or unsubsidized should be part of your decision process since there are different benefits to each one.

The benefits of Federal student loans

Yes, you can take your federal student loans and refinance them into a private loan if you choose. However, what you may not realize is the number of advantages a federal student loan offers versus a private loan. Once you refinance to a private option, you lose potentially valuable benefits.
Once you know these advantages, then you can make the decision based on what’s best for your financial situation. Federal loans include perks such as:
  • Student loan forgiveness program. The Public Service Loan Forgiveness, or PSLF program is for federal loans only. You may qualify for the remaining balance of your federal loans to be forgiven if you’ve worked at a non-profit organization for 10 years or 120 loan payments.
  • Income-based repayment plans. Repayment programs are offered that are based on your income. This means your monthly payments may be lower when your paycheck hasn’t reached its full potential.
  • No credit check. Federal loans do not require a credit check for qualification, but your payment history does get reported on your credit report.
  • No co-signer required.
  • Fixed interest rates.
  • Potentially lower interest rate. Depending on what you qualify for with private loans, a federal loan may have a lower interest rate.
  • Forbearance and deferment options: There are federal forbearance and deferment options available if you’re unable to make payments.
  • Your interest accrual begins after graduation, versus a private loan which begins right away.
  • Repayment grace period. A 6-month grace period is available for some federal loans.
  • Longer default period. The default period is 90 days for federal loans, while most private loans have a shorter default period.
  • Loans can be discharged. If a borrower passes away or is permanently disabled, the government can discharge the loan.
Private loans do not have many of the enhancements listed. You may find the new terms of the private loan outweigh the advantages of the federal loans.
And remember, once you refinance a federal student loan into a private loan, you can never refinance into a federal option.

Student loan consolidation

We’ve talked at length about refinancing private and federal loans, but what about consolidating loans? This is a term you often hear with refinancing, but it uses a different approach.
Consolidation of your student loans is a form of refinancing. With it, you have multiple loans combined into one new loan. The difference from refinancing is the interest rate is determined by the weighted average of all your previous interest rates. So it’s not necessarily an interest rate improvement.
However, consolidation is useful if you want to simplify your finances. This is especially critical with federal loans since it’s possible you have multiple and want to consolidate into one simple payment.

Consolidation of federal loans

Consolidation is actually required of your federal loans if you choose to participate in the PSLF or a repayment plan. To do this, you take out a Direct Consolidation Loan and it’s available for almost all types of federal loans.
You can not consolidate both federal and private loans together.
Private loan consolidation occurs only with private lenders, but it would likely end up being a refinancing option if you can qualify for a better interest rate or loan terms.
The other key point to remember with Federal loan consolidation is you still enjoy all the benefits of federal loans, such as repayment programs, or forbearance and deferment options.

Which should I choose? Refinance or consolidation?

In a nutshell, private loans should be refinanced if you see a benefit from a lower interest rate or longer payment term. If this improves your overall financial picture, then consider this a great option for your private loans.
Federal loans should only be refinanced into private loans if you’re sure you do not need to take advantage of the numerous benefits of federal loans. You can refinance a federal into a private loan, but you can never refinance into a federal loan.
Consolidation is advantageous mostly for federal loans. Consolidation is required for you to participate in the federal student loan forgiveness programs and repayment programs such as PAYE.


How do I refinance student loans?

If you want to move forward with refinancing, the process is straightforward.
To refinance a federal or private student loan into another private loan, you should get multiple quotes from multiple lenders. This way you compare interest rates, terms, and fees.
Sites such as Credible compare multiple lenders at once, so you are able to compare lenders side by side.
To formalize a quote for your new private loans, the lender requires an application and a review of your credit score and credit history. The higher your credit score, the more competitive interest rate you’ll qualify for. Most lenders require a minimum of 670 to approve your application for refinancing.
If you’re concerned your credit score isn’t strong enough to qualify for a private loan, you can use a co-signer. A co-signer can be a parent, grandparent, sibling, or friend. But before you head down this path — they are legally responsible for the repayment of the loan, even if you don’t pay. This also impacts a cosigner's credit score.

When should I refinance my student loans?

There is no defined time period to refinance your loans but there are times when it makes more sense. Consider these milestones as the ideal time to review your refinance options:
  • When you graduate from school
  • When you take a full-time job
  • You’ve improved your credit score
  • You’re offered an improved interest rate

How many times can I refinance student loans?

There is no limit to the number of times you refinance your loans and could be advantageous if you’re saving money each time. Make sure you confirm the fees before you sign on the paperwork, but generally speaking, private student loans have a low amount of fees.
The downside to refinancing multiple times is the impact on your credit. Each time you go through the loan application process, a lender performs a “hard pull” with your profile. If you apply for a loan from several lenders within a short period of time (14 to 45 days), it should be counted as just one hard inquiry.
For federal student loans, refinancing into another federal loan with another lender is not an option. However, you can enroll in one of the federal repayment programs or the Direct Loan Consolidation program once you meet the requirements of these programs.

How do I refinance student loans after consolidation?

If you’ve consolidated your student loans through the Direct Consolidation Loan or through a private lender, you can refinance your student loans. If you do, it’s the same process as if you were applying for a refinance with multiple loans.
You should compare lenders and receive multiple quotes to determine which lender offers the customer service, new terms, and new rates that work best for you.

What are the average student loan refinancing rates?

There are numerous lenders competing for your business to refinance your student loans. And more competition means you benefit from lower rates! Private student loan refinance rates range from 1.89% up to 6% or higher, but also depends on your credit score.
Don’t forget with private loans there are ways to earn discounts on your interest rate. For instance, many lenders offer incentives if you select automatic payments each month. You might even qualify for an additional discount if you have an auto loan or other financial product with the lender.

The bottom line

There are a wide variety of considerations to make when looking at refinancing versus consolidation for your student loans. If you do choose to refinance, it’s essential to know what benefits you’re giving up and what you’re gaining by signing up for new loan payment terms.

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