Student loan consolidation vs. refinancing: Which should you choose?

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Student loan consolidation vs. refinancing: Which should you choose?


If you're a student loan borrower in the U.S., you may be feeling the pinch of paying back your student loans. Managing your payments, as well as juggling various interest rates and lenders, can be overwhelming.

Student loan consolidation or refinancing could be a viable option to simplify your payments, or even save money, but what do these strategies entail? Though these terms are often used interchangeably, they're actually very different. We're here to break it down for you.

What is consolidation?

Student loan consolidation allows federal student loan borrowers to combine multiple loans into one loan that has a single interest rate and a single monthly payment. Borrowers can apply for a Direct Consolidation Loan through the U.S. Department of Education at no cost.

Jay Fleischman, a lawyer that specializes in student loans, says that the interest rate for a Direct Consolidation Loan is a fixed rate that's based on a weighted average of the current interest rates on the loans you're consolidating.

The interest rate is rounded up to the nearest one-eighth of one percent. In order to calculate your prospective interest rate, use this step-by-step formula provided by Edvisors.

Once your loans are consolidated into one payment, you retain the fixed interest rate for the life of your loan.

In order to be eligible for consolidation, you must have one Direct Loan or Federal Family Education Loan (FFEL) in repayment or in a grace period.

One exception to the rule is if you're in default. Borrowers can consolidate defaulted loans, but they must make arrangements with their loan servicer or repay the Direct Consolidation Loan with an income-driven plan.

Most federal loans are eligible for consolidation, and borrowers can generally start the process after they graduate or leave school or drop below half-time enrollment. Borrowers interested in consolidating their federal student loans can apply for a Direct Consolidation Loan through

What is refinancing?

Refinancing your student loans is similar to consolidation in that you're merging all of your loans into one single loan. However, refinancing could potentially get you a better interest rate than consolidation and sometimes allows you to combine your federal and private student loans.

The process of refinancing is different than that of consolidation in that private lenders will assess your financial situation before approval. Fleischman says, "When you refinance loans with a private lender, that lender could give you a new interest rate based on your credit score, income and overall financial picture."

In addition, instead of going through the U.S. Department of Education, you'd go through a student loan refinancing company in order to refinance your student loans.

Similarities and differences between consolidation and refinancing.

Though consolidating and refinancing are similar in the sense that they both merge your loans into one single payment, they have some important differences.

As previously mentioned, consolidation is only for federal student loans. In addition, your interest rate won't necessarily be lower -- it will simply be the weighted average of all your interest rates. Through refinancing, on the other hand, you could potentially lower your interest rates and save thousands of dollars in interest over the life of your loan.

The pros and cons of consolidating and refinancing.

Consolidating or refinancing your student loans can make a lot of sense if you're having trouble managing multiple payments. However, both options have pros and cons that should be taken into consideration.

Consolidation offers a repayment term of ten to thirty years, depending on the repayment term you select and the total amount of your loans. Having access to a longer repayment term may make managing payments easier, as it'll typically lower your monthly payment.

The downside is that this may increase your repayment period, which means you may pay more interest over time. In addition, consolidation may result in you losing certain borrower benefits, including interest rate deduction and loan forgiveness. These benefits can help borrowers save money on interest and, if you reach the point where your loan may be forgiven, ultimately reduce the cost of repayment.

Refinancing can be a good option for student loan borrowers with federal and private student loans who are looking for a better interest rate than they currently have. The key thing to consider, though, is that by refinancing, you are probably giving up federal protections such as income-based repayment and loan forgiveness.

In addition, depending on the lender, you may need, among other factors, a good credit score to qualify.

Lastly, it's important to take into account that refinancing companies may offer shorter repayment terms than what is available through consolidation, which means your monthly payments may be higher than what you were paying before refinancing.

Who should consolidate or refinance their loans?

Now that you know the difference between consolidation and refinancing, how should you choose?

If you have federal loans and are happy with your interest rates, you may want to stick with consolidation. In addition, consolidation can be a good option if you're currently in default.

"You should consider consolidating your federal student loans if you're in default, as doing so will bring you out of default and back into repayment immediately," Fleischman says.

If you're looking to save money on interest and you have a good credit score as well as steady employment, refinancing could save you money in the long run. Fleischman says, "You should consider refinancing a private student loan if you can get better terms (for example, a lower rate or payment amount) from another lender."

However, it's important to understand the borrower benefits you'll give up in order to refinance. And bear in mind, this doesn't necessarily have to be a choice - if you have a number of private and federal loans, you can refinance AND consolidate.

Bottom line

If you have student loans, consolidating or refinancing may be a good fit if you want to simplify your current payments. However, it's crucial to understand the differences between both and evaluate how each option benefits you as a borrower.

About the author: Melanie Lockert is a freelance writer and editor currently living in Portland, Oregon. She is passionate about education, financial literacy and empowering people to take control of their finances. Her work has been featured on Rockstar Finance, GoGirl Finance, The Globe and Mail and more.

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