Student Loan Consolidation vs. Refinancing: Here’s the Difference

consolidation vs. refinancing

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While people sometimes use the terms student loan consolidation and refinancing interchangeably, they can refer to two different processes. Direct loan consolidation is a federal option provided by the Department of Education, whereas refinancing is offered by private lenders, such as banks, credit unions, and online lenders. Let’s take a closer look at student loan consolidation vs. refinancing so you can decide which approach, if either, would be helpful for you.

What is student loan consolidation?

In a conversational sense, the term “consolidation” refers to combining multiple loans into one. Both federal consolidation and refinancing accomplish this.

But for this article, we’re going to use consolidation to refer to Direct Loan Consolidation, which is a federal option for federal student loans.

Direct Loan Consolidation combines your federal student loans into one loan to simplify repayment. Instead of tracking multiple loans and bills, you can pay back just a single student loan.

That said, you can “consolidate” a single loan via Direct Loan Consolidation. Why would you want to do this? Well, federal consolidation also lets you switch to a new loan servicer or extend your repayment terms to up to 30 years.

Direct Loan Consolidation is also one way to get student loans out of default and back into good standing.

Pros

  • You can combine several loans into one to simplify repayment.
  • You can choose a new loan servicer, which might be a welcome change if you’ve had problems with your old one.
  • You can extend your repayment terms to up to 30 years.
  • You can switch to a new repayment plan, such as income-driven repayment, extended repayment, or graduated repayment.
  • You can get defaulted student loans back into good standing.
  • You can make a Parent PLUS loan eligible for Income-Contingent Repayment.
  • You don’t have to pass a credit check to qualify.

Cons

  • You won’t save money on interest. In fact, your new rate could increase slightly, because it will be the weighted average of your previous rates rounded up to the nearest one-eight of a percent.
  • You could increase the long-term costs of your loan by extending your loan terms. More time in debt = higher interest costs.
  • You could trigger a capitalization event. Capitalization occurs when interest gets added onto your principal, meaning you end up paying interest on top of interest. Let’s say you have a principal of $30,000 and interest charges of $5,000. When you consolidate, your new balance is $35,000, so you’ll be paying additional interest on top of this higher amount.
  • You could reset the clock for Public Service Loan Forgiveness, which requires about 10 years of eligible payments. If you’ve been making qualifying payments on another repayment plan, consolidating could mean you lose credit for those payments you’ve already made.

What is student loan refinancing?

Now let’s take a closer look at student loan refinancing. Like consolidation, refinancing lets you combine multiple loans into one for simpler repayment. (Alternatively, you can refinance a single loan if that’s what you prefer.)

Refinancing is the process of taking out a new loan from a private lender and replacing one or more of your old loans with it. The main benefit is getting a lower interest rate, which could save you money on your debt.

The best refinancing lenders offer fixed rates starting at 2.89% and variable rates starting at 1.76%. (This is at the time of writing; make sure to check with lenders directly to see their current offers!)

If you refinanced a $35,000 loan from a 7.6% rate to a 3.00% rate, for example, you’d save $9,518 in interest over 10 years. Lowering your rate by a few percentage points can result in huge savings.

When you refinance, you’ll also get to choose new terms, usually between 5 and 20 years. Plus, your loan servicer will likely change to whichever bank you refinanced with (or whoever their loan servicing partner is).

Pros

  • You can snag a lower interest rate and save money on your student loans.
  • You’ll get to adjust monthly payments and choose new repayment terms.
  • You have the option of combining multiple loans into one for simpler repayment.
  • You’ll get a new lender and loan servicer.
  • You can shop around to find the best rate or lender with the most helpful borrower protections.
  • You can get a welcome bonus of up to $200 when you successfully refinance with our recommended lenders (check out the full list here).

Cons

  • Refinancing federal student loans turns them private, resulting in a loss of borrower protections. You’ll no longer have access to income-driven repayment plans, federal forgiveness programs, or Direct Loan Consolidation, for example.
  • You might have trouble qualifying, as private lenders want to see good credit and income.
  • You might have to apply with a cosigner to qualify or to get the best rates.
  • Your new lender will be private and likely won’t offer the same perks as the federal government. Some let you pause payments if you lose your job, but this isn’t guaranteed.

Learn more about the pros and cons of student loan refinancing in this guide!

Consolidation vs. refinancing: Which should you choose?

So, we’ve given you a lot to digest when it comes to Direct Loan Consolidation vs. student loan refinancing. At this point, you might be wondering which option, consolidation vs. refinancing, is right for you.

Well, one way to decide is by asking yourself the following questions:

  • What’s your student loan goal? If you want to simplify repayment while retaining access to federal payment plans, Direct Loan Consolidation could be the right move. If you want to save money on interest, explore your options for refinancing.
  • Do you need access to income-driven plans or federal forgiveness programs? If yes, refinancing federal student loans with a private lender probably isn’t a good idea. If no, you don’t have to worry about turning federal student loans private through refinancing.
  • Do you have strong credit and income (or a creditworthy cosigner)? If not, but refinancing is still your goal, take steps to improve your credit and apply again in the future. However, if your answer is yes, check your rates with some lenders to see your “pre-qualification” offers.

If neither the pros and cons appeal to you, you might simply leave your student loans alone and do what you can to chip away at your balance a little faster.

There’s no one-size-fits-all solution too student loan repayment. But by learning about your options and weighing the pros and cons, you can find the one that works best for you.

Want better rates? Here are the best banks to refinance student loans:

 Variable rates start at...Fixed rates start at...Repayment termsWelcome bonus Check your rates
refinance student loans1.90%3.39%5 - 20 years$200Visit LendKey
refinance student loans1.99%3.20%5 - 20 years$200Visit Earnest
refinance student loans1.99%3.50%5, 7, 10, 15, and 20 years$120Visit Laurel Road
refinance student loans2.00%3.10%5 - 20 years$100 or $200, depending on the amount you refinanceVisit Credible
refinance student loans2.31%3.46%5, 7, 10, 15, and 20 years$100Visit SoFi
refinance student loans2.39%3.14%5, 7, 10, 15, and 20 years$100Visit ELFI
refinance student loans1.81%3.21%5, 7, 10, 15, and 20 yearsN/AVisit CommonBond