By: Yara Zakharia, Esq.
Through the mechanism of student loan consolidation, borrowers have the possibility of refinancing their multiple student loans and easing the strain on their budgets. Federal student loan consolidation and private student loan consolidation assist students in managing their loan debt and decrease the likelihood that they will miss a payment.
The consolidation of a federal student loan is a repayment option whereby existing eligible federal education loans are merged into one new loan. A federal student loan consolidation is one of the best ways to streamline student loan repayment. This type of student loan consolidation is ideal for students who seek to lower their high monthly payments and those with several federal loans from different lenders or due dates.
The loans eligible for federal student loan consolidation are: 1) subsidized (based on financial need) Stafford Loans, 2) unsubsidized Stafford Loans, 3) Parent Loans for Undergraduate Students (PLUS), 4) Supplemental Loans for Students (SLS), 5) Perkins Loans, and 6) Nursing Student, Health Professions Student, and Health Education Assistance loans. To be eligible for this method of student loan consolidation, a minimum amount of $10,000 in federal student loans is required. To consolidate a federal student loan, the borrower must be in the grace period (that is, the six month period following the completion of studies at the college or university) or in a repayment, deferment, or forbearance period.
The second student loan consolidation option is private student loan consolidation, in which all student loans, including all private loans applied toward education-related expenses as well as any federal student loans, are merged. The private student loan consolidation provides $5,000–$275,000 for eligible borrowers to combine one or more existing private student loans into one new loan. Loans eligible for this form of student loan consolidation include 1) private education loans (any non-government education loan), 2) home equity loans, 3) loans or credit cards used for computer purchases, 4) loans from retirement plans, 5) loans used for travel expenses for school, and 6) loans from insurance policies.
Although these two types of student loan consolidation offer the same benefits in some respects, there are significant differences. Federal student loan consolidation offers the following advantages:
- A repayment schedule lasting up to 30 years
- A reduction in monthly payments up to 60%
- A low fixed interest rate for the life of the loan, which ranges from 4.75% to 6.125%, and is capped at 8.25%
- No penalty for early repayment
- A choice from among at least four flexible repayment plans (graduated, level, income-sensitive, and extended) based on the borrower's needs
- No credit checks and no origination or processing fees
- Availability of deferment and forbearance options
- Retention of subsidy benefits on loans that are consolidated into the subsidized portion of a Direct Consolidation Loan
This form of student loan consolidation has its downside, however, in that borrowers pay more in interest due to the longer repayment period and cannot benefit if rates decrease after they consolidate.
By contrast, a private student loan consolidation differs in several ways. First, borrowers must have good credit or apply with a credit-worthy co-signer. Secondly, interest rates, which are determined by the lender, are variable and reset monthly. This type of student loan consolidation carries a higher interest rate than federal student loan consolidation. The interest rate for a private student loan consolidation is the prime rate, adjusted monthly, in addition to a margin depending on the borrower's credit history. Thirdly, a one-time disbursement fee is added to the student loan amount at disbursement. Borrowers with loans exceeding $40,000 have a repayment period of up to 25 years, whereas for those whose loans are less than $40,000, the repayment period is 20 years. Next, while most lenders offering this type of student loan consolidation have repayment options authorizing deferment of the principal until the borrower graduates, some require borrowers to make interest payments while in school. Furthermore, with private student loan consolidation, borrowers might not be offered a grace period. Overall, this form of student loan consolidation is more costly than federal student loan consolidation. Nevertheless, on a positive note, since private student loan consolidation is credit-based, borrowers who consolidate their federal loans first (a recommended course of action) will be able to obtain a favorable interest rate in their private student loans due to an improved credit score.
In conclusion, although private student loan consolidation and federal student loan consolidation share similar features, the notable differences between them are worth considering. It is, therefore, important for borrowers to understand these two forms of student loan consolidation, since they will likely be repaying their loans for many years to come.
