Student Loan Consolidation Guide

1. What is Student Loan Consolidation?

Think of consolidation like a student loan taco. (Bear with us here.)

When you get out of school, you could have four or more different educational loans. They could be government loans or private-sector loans, and maybe you took out a new mix each school year. What's more, the separate loans probably have different repayment terms, interest rates and amounts owed.

Once you get out of school and have to start paying the loans, you could be swamped with bills and paperwork and have difficulty keeping them all straight. One solution is to roll all your individual school loans into one bigger loan, each of them an ingredient in your student loan taco. (We would advise against actually trying to consume your loan taco-at least not without a lot of hot sauce to make it go down.)

Consolidation is tempting for a variety of reasons. Perhaps you want to make one monthly payment instead of tracking many separate expenses. Or maybe you want to lower the total amount you're paying each month and extend your repayment term - which will increase the total amount you pay back. It could also be you simply hate your lender and want to take your business elsewhere.

It gets more complex if you have both federal loans and private ones. You generally can't consolidate private loans with federal loans-and it's usually a bad idea even when your lender allows it. Federal loans have generous terms and incentives to lower the financial barriers to college, and you may forfeit these perks by combining them with private loans. For that reason, many people try to keep their federal and private loans separate when consolidating.

If you want to consolidate, most any lender can help you. But you can only do it once within the lifetime of the loan-unless you are adding another new loan that you haven't already consolidated into the mix.

2. Should I Consolidate My Loans?

As with any financial decision, it depends. To start, you'll be able to make the wisest choice if you have a firm grasp on the terms of your student loans and how they might change under consolidation. For advice on student loans, see our guide.

Since it pays to keep federal and private loans apart, it's best to approach consolidation from both angles. Let's first examine whether it makes sense to consolidate your private student debt.

Private Student Loan Consolidation

Consolidating private student loans isn't always the best move. For starters, you usually do not get to lock in an interest rate when you consolidate your private loans. For instance, only one lender, Education Finance Partners, offers a fixed rate consolidation loan, but the rate is usually at least two percentage points higher than the rate they offer on non-fixed rate loans. Private consolidation is very similar to taking out a private loan-the interest rate is variable, not fixed, and is based on your credit score. In addition, you usually have to pay a one-time fee when consolidating private loans.

So why would anyone ever consolidate their private loans?

1.) If your credit score has improved from the time when you first took out your private loan, you might be able to consolidate your private loans at a lower rate than you currently have. Look at the interest rates you're paying, and see if better deals are out there.

2.) If you had a cosigner when you first took out a loan and you now have a good credit score of your own, you might be able to release your cosigner when you consolidate.

3.) In order to extend the repayment term on your private loans, say from 10 years to 15. Perhaps you borrowed more than you can handle and need to reduce your monthly payments. To cut down your monthly bills, you have to prolong your repayment period. Unlike federal loans, private loans don't normally have a fixed repayment schedule. So if you originally had 15-year repayment term, and you want to extend it to 25 years, you can do so when you consolidate. But remember, by extending the term you are ultimately driving up the total interest that you will pay over the life of the loan, sometimes substantially.

Federal Student Loan Consolidation

Presently, it's difficult to gauge whether or not you should consolidate your federal loans. Much of the calculation hinges on when you took your loans and whether they have fixed or variable interest rates.

Consolidation has its benefits, if only to make your loan picture simpler. If you took out a Stafford loan every one of the four or five years that you were in school, you will graduate with four or five separate Stafford loans. Same goes for every other federal loan you owe. Consolidation can simplify your life and help make sure you don't miss a payment.

It gets murky, however, when you try to figure out what interest rate you'll receive when you consolidate. If you merge your federal loans today, the interest rate is the weighted average of them all, rounded up to the nearest one-eighth of a percentage point. The rate cannot exceed 8.25%, and it will be locked in until the loan is repaid.

Unfortunately, it's not as clear if you borrowed prior to July 1, 2006. Since then, federal loans always have fixed rates when people first take them out as students: Stafford at 6.8%, Perkins at 5%, and PLUS at 8.5%. Before then, however, the interest rates on federal loans changed annually. If you took out loans before July 1, 2006, their rates will keep changing every July 1 unless you consolidate.

Here's an example: A 2007 college graduate might have three years of loans at variable rates because she took out her loans prior to July 1, 2006. So the rates will change every July 1 for the life of the loans. Her other loans came during the year following the cutoff, so they will be at fixed rates whether she consolidates or not. If you started school in 2006 or later, it's less complex because all your federal loans will have fixed rates.

In the past, you could just wait around until rates fell and consolidate when they hit a low rate. Now, since the rates are fixed, locking in rates is not so much an incentive for consolidation, except for those who have older loans that still fluctuate.

When deciding whether to consolidate federal loans, look at the loans you have. If you have variable interest loans and the rates are set to go down, you might want to consolidate then and lock in that rate. However, if you have fixed-rate loans, you don't have much to gain by consolidating.

3. Advice for Getting the Best Deal on Loan Consolidation

Let's be very clear: In almost every case, you shouldn't mix your federal and private loans. If you consolidate private and federal loans together with a new higher rate, you'll lose the advantage of the lower, fixed rate on your federal loans. Private lenders, on the other hand, will stick you with a less secure, variable rate.

Here are some other tips to help you make the wisest decision:

Keep your Perkins loan separate

If you consolidate, be aware that merging your Perkins loan with other loans is a bad idea. By law, a Perkins loan loses certain benefits when it is consolidated. For example, if you consolidate your Perkins loan before its nine-month, non-payment grace period is up, you will miss out on months of interest-free deferment.

If you go on to graduate school or have trouble finding employment after graduation, you can defer payment interest-free on your Perkins for up to three years. When consolidated, the Perkins loses this benefit.

If you're merely looking to stretch out repayment, try other options

Before leaping to consolidate your private loans and taking on additional fees or increased rates, call your current lenders and see if they will extend your repayment schedules. If lowering your monthly payments is your only reason for consolidating, your lenders will likely work with you to extend the terms of your current loans. After all, if you go elsewhere and consolidate, they'll lose your business. Invariably, extending the terms of your loans will mean higher total interest paid.

Consider the timing of consolidation

You can consolidate during the grace period before you have to make your first payment, or once you have entered repayment. For those with fixed-rate loans, it doesn't matter when you consolidate. But for those graduating with the old variable-rate loans, it is better to consolidate before the grace period expires.

There are two rates you can lock in when you consolidate these old loans. There's the in-school/grace-period rate and the repayment rate. In 2007, the in-school/grace period rate on a Stafford was 6.62% and the repayment rate was 7.22%. That three-fifths percentage point could add up to a substantial amount over the life of your loan. If you have variable-interest federal loans, it's best to lock in the lower grace-period rate.

4. Grilling Guide: Questions to Ask Lenders before Consolidating

Are there any fees associated with consolidation?

Many lenders will charge a one-time fee at the moment you consolidate. If you shop around, you may be able to find a lender who will waive this charge.

Will the interest rate on my consolidation loan, be fixed or variable?

There are only a handful of lenders offering fixed-rate consolidation. Best to ask upfront what your options are.

Can I extend my repayment term if I want to later on?

If the lender charges consolidation fees, but the only reason you wanted to consolidate was to extend your term, see if they'll let you do that without consolidating. If they want your business, the lender should be flexible enough to let you shorten or extend your repayment period based on your post-college situation.

What benefits could be lost by consolidation?

As we said, you can lose some attractive elements of your Perkins loan if you consolidate it. Other loans may have similar restrictions, and, as you know, if you mix federal loans with private you're sure to lose your low interest rate.

What borrower benefits and discounts are available?

As with regular loans, you might receive a break on your interest for consecutive on-time payments or drawing directly from your bank account when you consolidate. Of course, it may take 4 years worth of reliable payments to see that discount. As a result, many borrowers never realize such benefits.