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Debt consolidation entails taking out one loan to pay off many others. This is often done to secure a lower interest rate, secure a fixed interest rate or for the convenience of servicing only one loan.

Debt consolidation can simply be from a number of unsecured loans into another unsecured loan, but more often it involves a secured loan against an asset that serves as collateral, which is most commonly a house (in this case a mortgage is secured against the house.) The collateralization of the loan allows a lower interest rate than without it, because by collateralizing, the asset owner agrees to allow the forced sale (foreclosure) of the asset in order to pay back the loan. The risk to the lender is reduced so the interest rate offered is lower.

Because of the theoretical advantage that debt consolidation offers a consumer that has high interest debt balances, companies can take advantage of that benefit of refinancing to charge very high fees in the debt consolidation loan. Sometimes these fees are near the state maximum for mortgage fees. In addition, some unscrupulous companies will knowingly wait until a client has backed themselves into a corner and must refinance in order to consolidate and pay off bills that they are behind on the payments. If the client does not refinance they may lose their house, so they are willing to pay any allowable fee to complete the debt consolidation. In some cases the situation is that the client does not have enough time to shop for another lender with lower fees and may not even be fully aware of them. This practice is known as predatory lending. Certainly many, if not most, debt consolidation transactions do not involve predatory lending.

What is a Federal Student Consolidation Loan?

A Federal Consolidation Loan is a loan that you can use to pay off all or a portion of your original eligible federal student loans. You combine (consolidate) your existing federal student loan debt into one new loan.

What are the terms of a Federal Consolidation Loan?

o The interest rate on a Federal Consolidation Loan is fixed, meaning it will not change over the life of the loan, even if the interest rates on other federal loans go up (or down).

o The interest rate is calculated from the weighted average of the interest rates of your
existing loans, rounded up to the nearest 0.125%, with a cap of 8.25%.

o There are no fees to apply for or receive a Federal Consolidation Loan.

o The repayment term is up to 30 years, depending on the total amount of your student loan debt, and there is no pre-payment penalty.

Why should you consider consolidation?

With a Federal Consolidation Loan, you can benefit from:

o Lower monthly payments

o Fixed interest rates

o Only one payment for your federal loans each month

o New or renewed deferments

Because you are allowed up to 30 years to repay your loan, your monthly payment can be significantly lower with a consolidation loan, although you may pay more in total interest over the life of your loan.

When should you consolidate?

Only loans that are in grace, deferment, forbearance, or repayment can be consolidated into a Federal Consolidation Loan. Loans that have an in-school status cannot be consolidated.

There are no deadlines. However, Federal Stafford Loans that are in the grace period (or in deferment) have the lower rate compared to loans in repayment (or forbearance). Because the current interest rate is used in the calculation to determine the weighted, fixed interest rate of your consolidation loan, you will save money over the long run if you consolidate while in your grace period or while in deferment. (If you choose to consolidate while in your grace period, keep in mind that your grace period will be cancelled when the consolidation loan is issued and you will begin repayment.)

Student loan consolidation

In the United States, federal student loans are consolidated somewhat differently, as federal student loans are guaranteed by the U.S. government. In a federal student loan consolidation, existing loans are purchased and closed by a loan consolidation company or by the Department of Education (depending on what type of federal student loan the borrower holds). Interest rates for the consolidation are based on that year’s student loan rate, which is in turn based on the 91-day Treasury bill rate at the last auction in May of each calendar year.

Student loan rates can fluctuate from the current low of 4.70% to a maximum of 8.25% for federal Stafford loans, 9% for PLUS loans. The current consolidation program allows students to consolidate once with a private lender, and reconsolidate again only with the Department of Education. Once the student has consolidated their loans, the loans are set to a fixed rate based on the year they consolidated; reconsolidating does not change that rate.

Federal student loan consolidation is often referred to as refinancing, which is incorrect because the loan rates are not changed, merely locked in. Unlike private secton debt consolidation, student loan consolidation does not incur any fees for the borrower; private companies make money on student loan consolidation by reaping subsidies from the federal government.

Student loan consolidation can be beneficial to students’ credit rating, but it’s important to note that not all federal student loan consolidation companies report their loans to all credit bureaus; SLM Corporation (formerly Sallie Mae) does not report to Experian or Transunion, which means that students will have differing credit scores at Equifax, Transunion, and Experian.

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Student loan consolidation can be used by student or parent borrowers to combine their multiple education loans into one loan with one monthly payment. As any student can take either federal or private student loans, he or she can also take a federal or private consolidation loan to make the education debt more manageable.

Both federal and private student loans offer significant benefits, but federal loans offer borrowers many benefits that don’t come with private loans; for instance: low fixed interest rates, income-based repayment plans, loan forgiveness and deferment options. While some private lenders may offer them too, it usually is associated with some strings attached.

For those reasons, every borrower should always exhaust federal student loans options before considering a private loan. The same advice applies to consolidating student loans – always look at federal consolidation loan first and only if you don’t qualify for a federal loan of it is not the right choice for any reason, and then seek a private consolidation loan.

It is important to remember that a federal student consolidation loan can’t include any private loan. Moreover, if you consolidate your federal student loan into a private consolidation loan, you will lose your federal borrower benefits mentioned above (unless you private lender tries hard to get your business and includes them in the offer).

There are important differences between federal and private student loan consolidation.

First of all, with federal student loan consolidation, you will have a fixed interest rate, while private student loan consolidations are credit-based, which means that your consolidation loan rate will not be locked – it will be variable. So, while you will not have to go through credit check in order to apply for a federal consolidation loan, you will need it to secure a private consolidation loan.

Student loan consolidation rates are determined differently for federal and private consolidations. The interest rates for federal loans are set according to a formula established by federal statue. It’s a fixed rate, based on the weighted average of the interest rates on each of your loans at the time you consolidate, rounded up to the nearest 1/8th of a percent and capped at 8.25%.

As private student loans are not funded by the federal government, they are subject to the terms determined by each individual lender (bank, credit union, other financial institution) and the market competition. In private student consolidation loans a borrower’s credit is the primary factor in the variable interest rate offered to the borrower. As the base for setting the consolidation loan interest rate, the private lenders most often use the Prime rate or the 3-month LIBOR Rate, to which they add a margin. That margin varies from lender to lender and is applied according to the borrower’s credit rating.

With regards to the interest rate on the consolidation loan, it’s typical for both federal and private consolidation loan to include 0.25% rate reduction for automated debit payments.

Repayment of federal student consolidation loans begins within 60 days of the disbursement of the loan, with the payback term ranging from 10 to 30 years, depending on the amount of education debt being repaid and on other debts owned, as well as on the repayment option chosen by the borrower. Private student consolidation loans can also have repayment terms of up to 30 years, although they have fewer repayment options. Usually, repayment begins 30 days from the time your private student consolidation loan is funded.

While the most important factors looked at when deciding about how to consolidate student loans are the interest rates, borrower benefits and the terms of repayment, there are also other significant factors, such as: fees or cost to consolidate, prepayment penalties, loan amount limits, customer service, etc.

There are no fees or application costs whatsoever for processing and providing a federal student consolidation loan. It’s against the law to ask for advance (up-front) fees for arranging a federal education loan or consolidating federal education loans. However, some federal education loans (e.g. the Stafford and PLUS Loans) may require some fees, but they are always deducted from the disbursement check. On the other hand, private lenders may charge fees for application and processing private consolidation loans. Some private lenders charge fees as high as 4% of the principal you owe.

Federal consolidation loan programs don’t require a minimum balance to consolidate student loans; some private lenders require a minimum balance before they consider a borrower’s application for consolidation. That amount varies from lender to lender, but usually is between $5,000-$7,500 in US-issued private education loans.

With both federal private consolidations, there are no penalties for prepayment – all payments in excess of scheduled payments will go directly to principal and that will help to repay your consolidation loan faster.

The application process for consolidation of private student loans differs from the federal consolidation. Sometimes applications for private consolidation loans may be easier to complete (often done online or over the phone). However, it’s worth remembering that federal loans usually have lower interest rates, borrower benefits and better repayment terms than private student loans. Moreover, federal applications for both original loans and consolidation loans require FAFSA, so with the federal consolidation, your application is already partly completed.