If your student loans need improvement, there are several ways to simplify your life and reduce your expenses. Two common options are debt consolidation and refinancing. You may need to pursue one or both of these options, so it’s good to be aware of what they do (and do not do) for you.
Simplification and Improvement
First, it’s important to clarify the differences between debt consolidation and refinancing a student loan:
Debt Consolidation
Debt consolidation combines multiple loans into one loan. Instead of dealing with several separate loans and monthly payments and account statements, everything is consolidated and you handle it with one payment. You might think of this as “simplification” rather than actual consolidation.
True consolidation should only be possible if your student loans originally came from government programs. You can consolidate your private loans by grouping multiple loans together, but the main benefits of consolidation are reserved for government loans.
Note: Debt consolidation programs can cause confusion here. These are services offered by credit counseling agencies and similar organizations that negotiate with creditors to make payments more manageable. You make just one payment, but that payment goes to the agency, which in turn pays off your multiple loans on your behalf. This service is different from student loan consolidation.
Refinancing
When refinancing, you replace your loan with an entirely new one, ideally a much better loan. The goal is often to obtain a lower interest rate to reduce interest costs over the life of the loan and the monthly payment. You can also consolidate your loans when refinancing, by paying off multiple loans with your new loan. Rather than thinking of it as “refinancing,” think of it as “improving” your debt so that you pay less.
Consolidating Government Loans
When you have several government student loans, you can consolidate those loans using a Direct Consolidation Loan. The interest rate you pay will generally not change – you will end up with a weighted rate on the resulting loan that is effectively the same rate you were paying on those loans separately. This single fixed rate will apply to all the debt you consolidate, which may or may not be important. If you have one loan with a high rate compared to the others, it might be better to pay that off aggressively rather than adding it to your consolidation loan.
Consolidation may also allow you to change your repayment schedule. For example, you might be able to extend your repayment period to 25 years instead of a shorter term. However, a longer repayment term means you will pay more interest over the life of those loans. You will enjoy a lower monthly payment today at the cost of a higher overall cost in the long run.
What about merging government student loans with private loans? You can do this if you use a private loan (not through a Direct Consolidation Loan), but you’ll want to evaluate that decision carefully. Once you move a government loan into a private loan, you will lose the benefits of government student loans. For some people, these benefits may not be helpful, but you never know what the future holds, and features like deferment and income-driven repayment could be useful someday.
Refinancing with Private Loans
Consolidating a private loan is only an option if you refinance your debt. In the private market, lenders may be willing to compete for your loans, and you can secure a good deal if you have a good credit history. If you have been making your payments on time for years, your credit score should improve, giving you access to better interest rates.
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Refinancing can help you simplify things, but it really comes down to saving money. If you can get a lower interest rate (or any other benefit), you’ll be in a better position. Again, it’s possible to extend the repayment period over the coming years – every time you refinance, you start the repayment process over again – but that could cost you in the long run. To understand how this works, learn about an amortization schedule, which is a loan repayment process.
When refinancing with a private lender, you will end up with either a fixed or variable rate loan. Be sure to understand how the rate works. If interest rates change, will your monthly payments go up one day?
Dealing with Other Debts
While refinancing, it may be tempting to include other types of debt in your new loan (like an auto loan or credit card debt, for example). While it will simplify things, this generally can’t be done with student loans. However, there are other types of loans that can address different types of debt.
Personal loans can be used for anything. This means you can use a personal loan to refinance your student debt, one or two credit cards, and your auto loan. However, this doesn’t yield much savings unless you’re really going to save money. Avoid accumulating debt again as soon as you free up those credit lines.
Should You Consolidate Debt or Refinance?
The best course of action for you will depend on the types of loans you have and the options available to you.
If You Have Federal Student Loans
Weigh the pros and cons, especially if you’re tempted to switch to a private student loan. Using a federal consolidation loan isn’t without risks. However, switching from federal loans to private loans is not reversible – you’ll lose the benefits of those federal loans forever. For example, if you’re working in public service, you might have a chance to receive student loan forgiveness after 10 years of service. Good luck getting that offer from the private lender. Some federal student loan repayment plans may also allow for a lower monthly payment based on your income, but private lenders are less accommodating.
Separately consolidating federal loans (using a federal consolidation loan and dealing with private loans separately) gives you the simplicity of a single monthly payment for your federal loans, and you’ll get a fixed rate so you always know what your payment will be.
If You Have Private Student Loans
It’s always a good idea to shop around to see if you can get a better deal. Look for a lower interest rate, low (or no) application and processing fees, and other terms that mean you will truly save money. Create a quick amortization schedule for each loan, including your current loan, and choose the option that works best for you.
Source: The Balance
Source: https://www.thebalancemoney.com/debt-consolidation-vs-refinancing-4066810
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