In 2016, the total student debt burden equaled more than $1.3 trillion, with the average college graduate leaving school with an oppressive $37,172 in student loans. These statistics have been on the rise for some time, and have no end in sight. The combination of rising tuition costs and the implications of borrowing for one’s education has created a nation where over 44 million individuals have student loan debt that must be repaid.
But not everyone is capable of repaying their massive student loan balance, as the Consumer Financial Protection Bureau reports more than 7 million borrowers are currently in default. It isn’t all that surprising when you consider the stark truth about repayment: the average monthly loan repayment of $351 (for borrowers between the ages of 20 and 30) based on a 10-year repayment with an interest rate hovering around 6%. For individuals with a hefty balance left to repay, the monthly payment obligation often impedes on their ability to pay other bills or set money aside for the future. Both loan consolidation and refinancing are options to make your student loan more manageable in theory, either by reducing the interest rate or extending the repayment terms. First, however, it is important to understand how consolidation and refinancing work in practice.
What is a loan consolidation?
Consolidating your student loans means that multiple loans are combined into a single debt. Student loans are dispersed at different times throughout college or graduate level attendance, which creates numerous loans for a single borrower. Various interest rates are applied to each loan, depending on the type of loan utilized, and each comes with its own monthly minimum payment. Consolidation allows you to combine all loans which create one interest rate (which is the weighted average of all loans being consolidated) and one monthly payment.
Student loan consolidation is available only for federal loans, not private debts, and is not based on credit history or income. Consolidation is helpful in creating a more manageable repayment plan as it can result in a lower monthly payment and a fixed interest rate – an appealing reason to go through with the process.
What is refinancing?
Student loan refinancing is similar to consolidation in that it provides the borrower an opportunity to combine multiple loans into a single debt. However, refinancing is done through a private lender, not the federal government. Through a student loan refinance, you are effectively taking out a new loan to pay off already established loans through a bank or social lending institution. Both private and government loans can be combined into the new loan, but borrowers must qualify based on creditworthiness.
Refinancing student loans offers the same benefits as consolidation in that borrowers have the ability to have a single monthly payment obligation. Additionally, the time to repay can be reduced through student loan refinancing, and monthly payments may be lower if a smaller interest rate is offered.
The caveats to each
A federal loan consolidation is an attractive option for borrowers with student loans issued by the federal government, but it, unfortunately, does nothing for private loans. This means that borrowers who borrowed outside the government may continue to have multiple monthly payments and varied interest rates on each loan. Additionally, consolidation loan interest rates are fixed and may end up being higher than comparable private lender refinance loan options.
Student loan refinancing offers a solution for individual borrowers with a combination of loan types, but it has its drawbacks, too. Private lenders require full underwriting of a new loan (i.e. an individual’s credit score). Repayment history and income are reviewed before approval is granted so not all student borrowers qualify for a private lender refinance. Also, most refinance transactions through private lenders come with a variable interest rate. This means that the total cost of the loan may increase over time as may the monthly minimum payment obligation. On the surface, student loan refinances may look more appealing given the lower initial interest rate, but borrowers must understand that rates can – and will – fluctuate over time.
Another caveat to student loan refinancing is the loss of protection that is inherent to government student loans. In recent years, a number of programs were established to assist student borrowers with their burdensome loan obligations, including income-based repayment, extended repayment, and loan forgiveness. These initiatives are designed to make repayment easier and ultimately more flexible for borrowers over the long run, especially when financial circumstances change.
While federal student loan consolidation allows borrowers to maintain access to these programs, refinancing student loans with a private lender takes these options away. Whatever monthly payment your receive with the initial refinance transaction is the monthly payment you owe moving forward. There is no opportunity to shift that downward should you find yourself in financial need.
Which is my best option for my student loan?
Both student loan consolidation and loan refinancing provide borrowers with the opportunity to reduce the total number of monthly payments and interest rates. However, the two options do not provide the same benefits to every borrower. Student loan consolidation is typically best for individuals with substantial student loan debt and a myriad of interest rates for each loan. Consolidating eliminates the need to make monthly payments to a number of different loans. It also applies a fixed weighted average interest rate to the new loan. Repayment is flexible with student loan consolidation transactions due to federal government programs like income-based payments and forbearance. Student forgiveness through the government also remains an option for borrowers who qualify.
Student loan refinancing is a smart option for individual borrowers with a number of loans. Initially, refinancing may offer a lower interest rate than federal loan consolidation. But borrowers may be subject to changes in the interest rate environment over time. Individuals with a substantial amount of student loan debt may not be best served by private lender refinancing. They may ultimately lose access to helpful programs made available only for federal government loans. Take care to consider your options and fully understand the terms and conditions that apply to each.