Federal loan consolidation is a helpful tool for converting an unmanageable payment into a manageable payment by combining multiple semester loans into one loan and extending your repayment schedule.
In this section, you will learn how consolidation works, how to apply for federal loan consolidation, which loans can be consolidated, where to consolidate and how to best manage your loan once it is consolidated. (For background reading, see Debt Consolidation Made Easy.)
How Federal Student Loan Consolidation Works
You took out one loan per semester. If you began this process before July 2010 – when all federal loans started coming directly from the U.S. Department of Education – you may have borrowed through the Federal Family Education Loan Program. Each loan might have been from a different lender. If you finished in four years, you could have ended up with as many as eight different loans from up to eight different banks. Even if your loans are all from the Federal Direct Loan Program, it still pays to simplify them.
You can contact your lenders and/or the federal government's direct loan program to combine these loans into one Direct Consolidation Loan. The loans will be extended for a period of up to 30 years, depending on your loan balance. Your payments are reduced to reflect this lower payment.
What if you have the ability to pay off your loans earlier and can keep track of multiple lenders on your own? Consolidation does not stop you from paying off your loan early or sending in extra money to reduce your loan balance. You can pay off your loan early without any penalty. And while you may be able to keep track of up to eight lenders, it's convenient to have your loans in one place.
The other benefit to consolidation – besides a lower monthly payment – is lowering the likelihood of forgetting about a loan and accidentally going into default. This is because you won't have to manage so many loan accounts with a variety of lenders, which can easily lead to forgetting a lender or two.
This is why the first step in loan consolidation should be checking the national student loan database. Here, you can use the pin you acquired when you applied for your loans to access all your federal student loan records. In the records are your lender names and loan amounts. If you don't remember your pin, you can go to the pin website and request a duplicate pin.
Averaging Interest Rates
Consolidation loans have fixed rates. As StudentAid.ed.gov explains it, "The fixed rate is based on the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest one-eighth of 1%." What's more, "There is no cap on the interest rate of a Direct Consolidation Loan."
Since federal student loan rates are set on an annual basis, you could have a different interest rate for loans taken out in different school years. Your interest rates are averaged based on the cumulative interest rates of your loans and weighted by the amount of your loans. Luckily, each lender you currently have has already averaged your interest rate for the loans you have with that institution. The only averaging that will likely happen is combining the interest rates pre-averaged by each lender.
For instance, if you have loans from two different lenders and one lender's total loan amount is $10,000 at an interest rate of 4% and the other's total loan amount is $20,000 at an interest rate of 5%, you have a total of $30,000 in student loans. If you divide $10,000 by $30,000, you'll see that one-third of your loans are at 4%. If you divide $20,000 by $30,000, you'll see how two-thirds of your loans are at 5%. One-third of 4% plus two-thirds of 5% equals an average interest rate of 4.67%.
What Happens to Variable-Rate Student Loans
Before July 1, 2006, federal student loans did have variable interest rates. If you took out a loan before that date, your rate changes when the new interest rate for federal loans is revealed annually in July. Consolidating these loans with your other loans will permanently stabilize your interest rate to the average of the interest rates of all your federal loans.
Subsidized vs. Unsubsidized Loan Consolidation
If you have both subsidized and unsubsidized loans, when your loans are consolidated they will be kept separate within your new Direct Consolidation Loan. The reason: If you return to college at a later date or qualify for a deferment during which you wouldn't be charged interest on your subsidized loans, they need to be tracked separately.
Benefits of Student Loan Consolidation
When you extend payments you are freeing up your finances to pay down high-interest credit cards, put money toward your retirement or buy a home.
Sample Repayment Table for Consolidated and Standard Repayment Loans
Assume in this table an interest rate of 6.8%.
|Total Loans||Standard 10-Year Repayment||Consolidation Repayment Period||Consolidated Payment|
Benefits Previously Given
If you or any of your friends consolidated before November of 2007, you may have received or heard about borrower benefits such as 2% interest deductions after 36 months of on-time payments. If you were lucky enough to consolidate while these borrower benefits existed, it's important that you do everything you can to keep your benefits.
Sign up for online access with your lender so you can verify that all your payments are received by viewing your account online. If you experience a financial difficulty, make sure you ask about deferments or forbearances. Your borrower benefits will still apply and you can continue to build your number of on-time payments toward the 36 required for the interest rate reduction after your deferment or forbearance expires.
But be careful about when you stop making payments in a financial difficulty. If you apply for a deferment don't stop making payments until your deferment is approved, or you will violate the terms for your receiving your benefit.
Even if you have consolidated your loans, you could still have a loan that isn't involved in the consolidation and will go into default if you don't make payments. The reasons one or more loans may not be part of your consolidation loan is you returned to school after you consolidated your loans or you just forgot to include one you didn't know you had.
Check the national student loan database to find all your loans prior to consolidation; you can reconsolidate if any are missing from your previous consolidation. (For more on consolidation, see Digging Out Of Personal Debt.)
Also be aware that you could lose some benefits of individual loans if you consolidate. Or, if you have one loan at an especially low interest rate, you may end up paying more. Investigate all these options carefully before you decide on loan consolidation and which of you loans you want to consolidate.
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