several student or parent loans into one bigger loan from a single
lender, which is then used to pay off the balances on the other
loans. It is very similar to refinancing a mortgage. Consolidation
loans are available for most federal loans,
including FFELP (Stafford, PLUS and SLS), FISL, Perkins, Health
Professional Student Loans, NSL, HEAL, Guaranteed Student Loans and
Direct loans. Some lenders offer
private consolidation loans
for private education loans
as well.
A separate page provides a comparison chart of consolidation loan discounts.
Interest Rates
The interest rate on a consolidation loan is the weighted average of
the interest rates on the loans being consolidated, rounded up to the
nearest 1/8 of a percent and capped at 8.25%.
For example, suppose a student has just unsubsidized Stafford Loans originated
on or after July 1, 2006. These loans have a fixed interest rate of
6.8%. When they are consolidated by themselves, the consolidation loan
will have an interest rate of 6 and 7/8ths of a percent, or 6.875%. So
the interest rate increases only slightly.
If the borrower has a mix of loans with different interest rates, the
weighted average will be somewhere in between. For example, if the
borrower has $5,000 of Perkins Loans (at 5.0%) and $10,000 of
unsubsidized Stafford
Loans (at 6.8%), the weighted average is
$5,000 * 5.0% + $10,000 * 6.8%
------------------------------ = 6.2%
$5,000 + $10,000
This weighted average, 6.2%, is then rounded up to the nearest 1/8th
of a percent, yielding a consolidation loan interest rate of 6.25%.
Note that the weighted average does not fundamentally alter the
underlying cost of the loan. It preserves the cost structure by
including each interest rate to the extent that it applies to part of
the overall loan balance. For example, the consolidation loan in the
previous paragraph says that of the $15,000 consolidation loan
balance, $5,000 will be at 5.0% and $10,000 at 6.8%, yielding an
equivalent interest rate of 6.2%.
If you are consolidating loans with different interest rates, the
weighted average interest rate will always be in between. Don't be
fooled if someone tries to suggest that this will save you money by
getting you a lower interest rate. The interest rate may be lower than
the highest of your interest rates, but it is also higher than the
lowest of your interest rates. More importantly, the amount of
interest you pay over the lifetime of the loan will be about the
same.
(For the mathematically inclined, there is a slight difference
due to the different shapes of amortization curves at each interest
rate. In the example given above on a 10 year term, $10,000 at 6.8%
has a monthly payment of $115.08 and total interest paid of $3,809.66,
$5,000 at 5.0% has a monthly payment of $53.03 and total interest paid
of $1,364.03. If you add these, you obtain a total monthly payment of
$168.11 and a total interest paid of $5,173.69. Using the weighted
average, $15,000 at 6.2% has a monthly payment of $168.04 and a total
interest paid of $5,165.01. So using a weighted average yields a very
small reduction in the monthly payment (in this case, 7 cents) and
in the total interest paid ($8.68) due to a kind of triangle law. Of
course, when you consolidate the interest rate is rounded up to the
nearest 1/8th of a point, so $15,000 at 6.25% has monthly payments of
$168.42 and total interest of $5,210.42, yielding a slight
increase. So you pay a tiny bit of a premium for consolidation, due to
the rounding up of the interest rate.
The PLUS loan interest rate loophole
can reduce the interest rate on 8.5% fixed rate PLUS loans by 0.25%
through consolidation.
If you were deferring the interest on an unsubsidized Stafford Loan by
capitalizing it, most lenders will add the capitalized interest to
principal when you consolidate. (Lenders can capitalize interest at
most quarterly, but most capitalize it once when the loans enter
repayment or at other loan status changes.)
No Cost to Consolidate
Aside from a slight increase in the interest rate on the consolidation
loan, there is no cost to consolidate your loans. There are no fees to
consolidate.
Under no circumstances pay a fee in advance to get a federal education loan
or consolidate your federal education loans. There are no fees to
consolidate your loans. While other federal education loans, such as
the Stafford and PLUS loans, may charge some fees, the fees are always
deducted from the disbursement check. There is never an up front
fee. If someone wants you to pay an up front fee, chances are that it
is an example of an advance fee loan
scam.
Who Can Consolidate
Both student and parent borrowers can consolidate their education
loans. (Students and parents cannot combine their loans through
consolidation, since only loans from the same borrower can be
consolidated. But they can consolidate their loans separately.)
Married students are no longer able to consolidate their loans
together. This provision was repealed effective July 1, 2006. When
married students consolidated their loans together, each spouse became
responsible for the full amount of the loan, and the loans could not
be separated if the couple got divorced. To avoid such problems in the
future, Congress decided to repeal this provision as part of the
Higher Education Reconciliation Act of 2005.
Students can only consolidate their education loans during the grace
period or after the loans enter repayment. (Loans that are in default
but with satisfactory repayment arrangements may also be consolidated.) Students can
no longer consolidate while they are still in school. (The
early repayment status
loophole
and the ability of Direct Loan borrowers to
consolidate during the in-school period was repealed as part of the
Higher Education Reconciliation Act of 2005, effective July 1, 2006.)
Parents, however, can consolidate PLUS loans at any time.
You Can Consolidate with Any Lender
Students and parents can consolidate their loans with any lender, even
if all of their loans are with a single lender. (The
single holder rule was repealed on June 15, 2006, as part of the
Emergency Supplemental Appropriations Act of 2006. Borrowers no longer need to
exploit the
single holder rule loopholes
in order to consolidate with any lender.) Direct Loans can also be
consolidated with any lender. This allows you to shop around
for a lender that offers a lower rate or better discounts.
Most lenders require a minimum balance before they will consolidate
your loans. For example, many lenders will only offer consolidation
loans for borrowers with loan balances of at least $7,500. A few
lenders will offer consolidation loans for balances of $5,000 or more,
and the Federal Direct Consolidation Loan program has no minimum
balance for consolidation loans.
(Lenders may not discriminate against borrowers who seek consolidation
loans on the basis of number/type of student loans, type/category of
educational institution, the interest rate on the loans, or the type
of repayment schedule sought by the borrower. Lenders are, however,
able to discriminate on the basis of the amount of the loans being
consolidated, so lenders can set a minimum balance on the loans.)
Which Loans Can be Consolidated?
Any federal education loan can be consolidated. You can even
consolidate a single loan. There are, however, a few restrictions on
consolidating a consolidation loan.
You can consolidate a consolidation loan only once. In order to
reconsolidate an existing consolidation loan, you must add loans that
were not previously consolidated to the consolidation loan. You can
also consolidate two consolidation loans together. But you cannot
consolidate a single consolidation loan by itself. These restrictions
have been in effect since early 2006.
Note that when you reconsolidate a consolidation loan, it does not
relock the rates on the consolidation loan. The consolidation loan is
treated as a fixed rate loan within the weighted average interest rate
formula used to calculate the interest rate on the new consolidation
loan. Consolidation does not pierce the veil on previous
consolidations.
The new restrictions on consolidating a consolidation loan limit your
ability to use consolidation to switch lenders. Generally, you will
consolidate your loans once, toward the end of the grace period or
after the loans enter repayment, and then be locked into that
lender for the lifetime of the loan. If you want to preserve your
ability to use consolidation in the future to switch lenders, you
should exclude one of your loans from the consolidation.
Repayment Plans
Consolidation loans provide access to several alternate
repayment plans besides standard
ten-year repayment. These include extended repayment, graduated
repayment, income contingent repayment (Direct Loans only) and income
sensitive repayment (FFEL only). If you do not specify the repayment
terms, you will receive standard ten-year repayment.
Consolidation loans often reduce the size of the monthly payment by
extending the term of the loan beyond the 10-year repayment plan that
is standard with federal loans. Depending on the loan amount, the term
of the loan can be extended from 12 to 30 years. The reduced monthly
payment may make the loan easier to repay for some borrowers. However,
by extending the term of a loan the total amount of interest paid over
the lifetime of the loan is increased.
In certain circumstances (for example, when one or more of the
loans was being repaid in less than 10 years because of minimum
payment requirements), a consolidation loan may decrease the monthly
payment without extending the overall loan term beyond 10 years. In
effect, the shorter-term loan is being extended to 10 years. The total
amount of interest paid will increase unless you continue to make the
same monthly payment as before, in which case the total amount of
interest paid will decrease.
You do not need to pick an alternate repayment plan. We recommend
sticking with standard ten-year repayment, because it will save you
money. The alternate repayment plans may have lower monthly payments,
but this increases the term of the loan and the total interest paid
over the lifetime of the loan.
See our
caveat about extended repayment below.
Repayment on a consolidation loan will begin within 60 days of
disbursement of the loan, unless the borrower qualifies for an
deferment or forbearance.
Federal education loans, including consolidation loans, do not have a
prepayment penalty. So you can pay off all or part of your federal
education loans without incurring a penalty. If you want to take
advantage of this, be sure to include a letter with the extra payment
indicating that it should be applied to reducing your
principal. Otherwise, the lender may treat it as an advance payment of
the next month's monthly payment.
Tools for Evaluating Consolidation Options
FinAid's
Loan Consolidation
Calculator can help you understand the tradeoffs of consolidating
your loans. It compares the reduction in the monthly loan payment with
the increase in the total interest paid over the lifetime of the
loan. It also shows you the interest rate on your consolidation loan.
Despite the
switch to fixed interest rates on Stafford and PLUS loans eliminating
a key financial incentive to consolidate, there are still
several
reasons to consolidate your education
loans. These include having a single monthly payment, access to
alternate repayment plans, the
PLUS loan interest rate loophole,
and the ability to reset the 3-year clock on deferments and
forbearances. But consolidation can cut short the grace period,
although the grace period loophole
can work around this problem.
It is best to avoid consolidating Perkins loans, because you lose
several valuable benefits. Beware of extending the term of your loan,
as this can increase the total interest paid over the lifetime of the
loan; you can stick with standard ten-year repayment.
Before consolidating, always evaluate the benefits provided by the
current holder of your loans. The loan discounts offered by
originating lenders tend to be superior to those offered by
consolidating lenders, since consolidation loans have tighter
margins. Also, if you received a fee waiver or rebate from the
originating lender, you may have to repay that discount if you
consolidate with another lender. It may be possible to get some of the
benefits of alternate repayment plans without consolidating, such as
extended/graduated repayment with a loan term of up to 25 years and a
single monthly payment, if you have more than $30,000 in federal
education loan debt accumulated since October 7, 1998 with the
lender. (This is due to a little known provision of the Higher
Education Act, in section 428(b)(9)(A)(iv), and the regulations at 34 CFR 682.209(a)(6)(ix).)
You can change the repayment schedule on your loan once per year. So
consider starting off with standard ten-year repayment on your
consolidation loan. You are not required to start off with extended
repayment. If you find it difficult to afford the
payments, you can always switch to extended repayment later.
For More Information
FinAid has a page of
common questions about consolidation.
The numerous
student loan loopholes
are discussed in depth in other sections of the FinAid site.
FinAid also maintains a list of education lenders who offer
federal and private student loans,
including consolidation loans.
If your school participates in Direct Lending, you should visit the
US Department of Education's Federal Direct Consolidation Loan
web site.
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