Direct Consolidation Loan Definition

What Is a Direct Consolidation Loan?

The term direct consolidation loan refers to a type of federal loan that combines two or more federal education loans into a single loan. A direct consolidation loan comes with a fixed interest rate that is based on the average rate of the loans that are consolidated. Consolidating through the direct consolidation loan program comes at no cost to the borrower. Individuals must complete an application, which is free.

Understanding Direct Consolidation Loans

Direct consolidation loans allow borrowers to lower the number of loan payments they have to make each month, combining them into a single payment. These loans are facilitated by the U.S. Department of Education and don't require borrowers to pay an application fee. Most federal loans are eligible for consolidation, but private loans aren't eligible. Borrowers can consolidate once they complete school, withdraw from school, or fall below half-time student status.

Loan consolidation also can give someone access to additional loan repayment plans and loan forgiveness programs. Loan forgiveness programs allow a borrower to cancel their obligation to repay all or a portion of the remaining principal and interest owed on a student loan.

The most common consolidation programs are the Teacher Loan Forgiveness Program and the Public Service Loan Forgiveness (PSLF) program. With loan forgiveness, borrowers aren't required to pay income tax on loan amounts that are canceled or forgiven based on qualifying employment.

Temporary changes made by the federal government in August 2022 let student borrowers get credit for payments made on loans from Federal Family Education Loan (FFEL) Program, Perkins Loan Program, and other federal student loans through the PSLF program. These borrowers had to apply to consolidate their loans into a direct consolidation loan before Oct. 31, 2022, to qualify under the temporary changes.

Eligibility of FFEL Loans for Forgiveness

The nation’s highest court was to hear oral arguments on Feb. 28 in a case challenging President Joe Biden’s authority to forgive up to $20,000 of student loan debt per eligible borrower through the Department of Education. 

Originally, if FFEL or Perkins loans eligible for the student loan payment pause that began in 2020, they have been said to be eligible for the Biden debt cancellation offering. If they weren't eligible for the pause, then they weren't qualified for debt cancellation, if the presidential action is upheld by the Supreme Court and is granted.

Before Sept. 29, 2022, the Education Department told borrowers they could consolidate FFEL loans not held by the department into a federal direct loan, which would have made them eligible for forgiveness through Biden's plan. But on Sept. 29, the department updated its website to say that consolidation of commercially held FFEL loans was no longer possible, although applicants for consolidation before that date would be granted the consolidation.

Direct Consolidation Loan Process

Direct consolidation loans are made through the Federal Direct Student Loan Program. The Federal Direct Student Loan Program allows students, as well as parents, to borrow directly from the U.S. Department of Education at participating schools.

Before getting a direct consolidation loan, it is important to consider any benefits associated with the original loans, such as interest rate discounts and rebates. Once the loans are rolled into a new direct consolidated loan, borrowers typically lose those benefits. Additionally, if the new loan increases the repayment period, the borrower may wind up paying more interest.

The consolidation of federal educational loans is free and the process is fairly simple. Private companies may reach out to borrowers to offer to help with this process for a fee, but they are not affiliated with the Department of Education or its federal loan servicers.

After completing an application, the borrower confirms the loans they are seeking to consolidate, then agrees to repay the new direct consolidation loan. Once this process is complete, the borrower will then have a single monthly payment on the new loan, instead of multiple monthly payments on several loans.

Pros and Cons of a Direct Consolidation Loan

Pros Explained

The advantages of a direct consolidation loan are fairly straightforward. You may be eligible for lower monthly payments because the repayment term is extended up to 30 years. In addition, you only have to make one payment per month. This can make it easier to keep track of your student loan balance.

You also can get a lower interest rate because direct consolidation loans have a fixed interest rate. Since July 1, 2006, all federal student loans have had a fixed interest rate. However, some loans disbursed before this date have variable interest rates. Consolidation can help turn a variable rate into a fixed one, a potential advantage when interest rates are increasing.

Borrowers also may get access to different repayment options. These types of repayment plans are available for direct consolidation loans:

• A standard repayment plan
• A graduated repayment plan
• An extended repayment plan
• The Income-Contingent Repayment (ICR) Plan
• The Pay As You Earn (PAYE) Repayment Plan
• The Revised Pay As You Earn (REPAYE) Repayment Plan
• An Income-Based Repayment (IBR) Plan

Loans come out of default status once they’re consolidated. If you’re in default on one (or all) of the loans you want to consolidate, this may be a good option for you, but you'll have to meet certain requirements. (You must make three consecutive monthly payments on the defaulted loan first or agree to repay your new direct consolidation loan through one of several different options of repayment plans.)

Borrowers who obtain a direct consolidation loan also can gain access to loan forgiveness options, including the PSLF program.

Cons Explained

When loans are consolidated, the interest on the consolidated loan is based on a weighted average of the rates on their old loans, rounded to the nearest one-eighth of a percent (0.125%). This rounding means that the interest rate on a consolidated loan may be slightly higher, or slightly lower, than the average rates of the previous loans.

Borrowers should also keep in mind that their debt may actually increase. Because consolidation extends the repayment period—perhaps to 30 years—your monthly payment is lowered but this also results in you paying more money over the life of your loan.

You don't get a grace period with a direct consolidation loan; the repayment period starts immediately upon consolidation, and the first payment will be due in around 60 days. In addition, if your loans were in default, you won't get an automatic credit boost if you consolidate your loans.

Prior loan payments before you consolidated won't count toward loan forgiveness requirements. Additionally, there are some benefits you may lose by consolidating your loans. These include reduced interest rates, principal rebates, repayment incentive programs, or loan cancellation benefits available under the loans that you’re consolidating.

Is Direct Loan Consolidation the Right Choice?

There are several different reasons why you might choose direct loan consolidation. If tracking multiple student loan payments is difficult, consolidating all your federal loans into a single monthly payment may be beneficial for you.

Not all federal loans are eligible for income-driven repayment plans. By opting for direct loan consolidation, you will be able to access income-driven repayment plans. You may also opt for direct loan consolidation if you want to be eligible for certain loan forgiveness programs. With an income-driven repayment plan, you can qualify for forgiveness of the remaining balance at the end of the repayment term.

Additionally, direct loan consolidation may be the right choice if you want a fixed interest rate. If you have federal loans that were disbursed before July 1, 2006, one or more of your loans may have a variable interest rate. Direct consolidation loans have fixed rates only.

The Bottom Line

If you're making payments on multiple federal student loans but have trouble juggling them, you may want to consider a direct consolidation loan. This program takes all your loans and combines them into a single loan with a fixed interest rate. There's no credit check involved, and you don't have to pay an application fee.

Keep in mind, though, that you lose any benefits associated with your other loans and you may pay more interest over the life of your consolidation loan. If you're interested, be sure to visit the Department of Education's website for more information and to fill out the application.