Understanding the difference between student loan consolidation and refinancing can be confusing. In this article, we examine the key differences between the two and compare the positives and negatives of both options. We also discuss the conditions when you might want to select one over the other.
What is the difference between loan consolidation and refinancing?
So let’s start with the basics. While the terms are often used interchangeably, consolidating your loans is not the same as refinancing them.
Loan consolidation is the process of taking out a new loan that combines some or all of your existing loans into a single loan with just one monthly payment. In the context of student loans, loan consolidation typically refers to consolidating multiple federal loans into one loan, which will typically be a Direct Consolidation Loan. While most federal student loans can be consolidated, including loans from the Direct, Perkins, and Federal Family Education loan programs, there are many rules on what loans can be consolidated together and what the terms of the new loan should be.
Refinancing involves paying off an existing individual loan and replacing it with a new one with different repayment terms, generally at a lower interest rate or a lower monthly payment. Note that refinancing may include consolidating your loans if you’re refinancing more than one loan.
You can refinance both federal and private student loans (either separately or together), while government-backed consolidation is available for federal loans only. You can still consolidate private student debt by refinancing with a private lender.
Consolidation vs. refinancing: benefits and negatives
|Private Loan Refinancing|
When to consolidate vs. refinance
Now that you know some of the basics of student debt consolidation vs. refinancing you can consider which is right for you. It’s important to remember that there is no one-size-fits-all solution and that there are a number of factors you should consider before going down either route. These include:
Your specific set of circumstances
If you have multiple different student loans and are you are struggling to keep track of your various payments then consolidating them into one single monthly payment might seem like just the way to simplify your debt repayments. Alternatively, you might be looking to get on an income-driven plan for which you need to consolidate your existing debt. For example, Perkins Loans aren’t eligible for certain income-based repayment plans such as Pay-as-you-earn (PAYE), Revised Pay-as-you-earn (REPAYE), Income-based Repayment (IBR), or Income-contingent Repayment (ICR) unless you consolidate them first.
At the same time, there are a whole host of reasons why you might want to privately refinance. For instance, your existing loans have a higher interest rate and you want to lower them, you have a steady job and are confident you can make your monthly loan payments. Or, you might have built up a strong credit score and are looking for more competitive rates.
There might also be scenarios when it makes sense to both consolidate your federal student debt and private refinance.
Before you can move forward you will need to understand the eligibility criteria associated with all the various consolidation and refinancing options out there.
While every plan will have its own individual criteria, many private refinancing providers will consider things such as whether you have stable income (typically more than $25k per year), your debt-to-income ratio (generally lower than 40-45%) and your credit history (Good credit/660 or above generally required) among other things. There may also be stipulations around the minimum/maximum student debt balance, whether you have graduated and your repayment history on your existing loans.
Generally speaking, federal consolidation loans have significantly fewer eligibility requirements than private refinancing programs as private lenders are looking at creditworthy borrowers. For instance, Federal consolidation does not require a credit check and is available to people currently in default.
Understanding the eligibility criteria associated with specific refinancing or consolidation options before you make an application is crucial as failed applications can harm your credit health.
The other factor to consider when applying for student debt consolidation or refinancing is the specific application process and what information is required both to be approved and to determine your interest rate and repayment terms. Exact requirements vary and depend on what support you are looking for. Information can include everything from proof of income (pay stubs), social security number, household costs (eg. mortgage), billing statements for existing loans and employers’ details.
Note that the application process for a Federal Direct Consolidation Loan is very different to private refinancing options.