Student loan refinancing vs. consolidation. Same thing, right? Not quite. Boston Student Loan Lawyer, Adam S. Minsky, Esq., breaks down the differences.
During the past several years, there’s been a surge of new refinancing programs for student loan borrowers. This is generally good news, as borrowers do need more options to manage their student loans and repay their debt more effectively.
But whenever there are new financial programs to help consumers, there is inevitable confusion. Restructuring your student loan debt can have major benefits, but it can also lead to serious, long-term repercussions. It’s important to untangle fact from fiction and understand what your options are. Here are some of the most common misconceptions I see about these programs in my student loan practice.
Refinancing and Consolidation Mean the Same Thing
“Refinancing” means taking out a new loan to pay off and replace an older loan; people usually do this to obtain better repayment terms, such as a lower interest rate or a longer time period to repay the balance. “Consolidation” involves combining several separate loans into a single new loan.
In the student loan context, these differences can get muddled by the fact that the term “consolidation” is often specifically used in reference to a federal program that allows borrowers to combine their federal student loans into a single federal “Direct Consolidation loan;” it’s possible (in certain circumstances) to “consolidate” a single federal loan by itself via this student loan consolidation program. Meanwhile, student loan “refinancing” is usually a term reserved for private loans, in part to differentiate it from the Direct consolidation loan program. However, if you refinance several individual student loans through a single private refinancing program, it can technically be a “consolidation” as well (since you are combining those separate balances into one new loan).
You’ll Always Get a Lower Interest Rate
One of the main reasons people want to refinance their student loans is to get a lower interest rate. This can result in lower payments and substantial savings over time. But an interest rate reduction is far from guaranteed.
For the federal Direct Consolidation program, there is no way to get a lower interest rate. Period. Interest rates for federal loans are set by Congress, and the interest rate for a new Direct Consolidation loan is fixed at the weighted average of the underlying loans you’re consolidating. In other words, it’s interest-neutral.
For private student loan refinancing programs, it’s more complicated. It’s possible to get a lower rate, but it’s not guaranteed, and it depends on the strength of your application. Refinancing companies are typically looking for borrowers with excellent credit (a score of least 680), and sustained strong earnings. If either element is lacking, you may not get approved.
But not all interest rates are equal. Borrowers shopping around for a private refinancing program should be careful of variable rates and other loan terms that can cause your seemingly-lower interest rate to increase later. You might be attracted by an initially low rate, but future increases could wipe out any financial benefit of the program.
You Can Consolidate your Federal Loans and Private Loans
Whether you can consolidate your federal and private loans together depends on the program. The federal Direct Consolidation program is only available for federal loans, so there is no way to combine private loans and federal loans together within the federal system.
A private refinancing program can be used to refinance (and consolidate) both private and federal loans. However, refinancing federal loans through a private program would mean that you’d be giving up important programmatic benefits and consumer protections unique to the federal student loan system such as flexible repayment options, Public Service Loan Forgiveness and other profession-based forgiveness programs, a disability discharge, and the right to cure default. Since private loans are excluded from the federal consolidation program, you can’t re-convert a refinanced loan back into the federal system if you have second thoughts later on. That’s a potential deal-breaker for many student loan borrowers, even with an interest rate reduction.
A Lower Interest Rate is the Most Important Consideration
Since the interest rate of a student loan directly impacts the cost of repayment, it’s understandable that people focus on that. But there are important considerations.
Some federal loans – such as Graduate PLUS loans and Parent PLUS loans – can have fairly high interest rates, which might make refinancing an attractive option. However, remember that by doing so, you’re effectively walking away from the critical benefits and protections unique to the federal student loan system. Are you willing to risk that?
People sometimes also express interest in refinancing student loans through a home equity loan or mortgage refinancing product to get a lower interest rate. But this can be risky, as well. The reason you’re able to get a lower interest rate through a home loan is because that loan is secured by the house itself; if you encounter a hardship and can no longer afford the payments, the lender can take your house. Student loans, in contrast, are unsecured, meaning there is no asset tied to the debt obligation. By converting an unsecured loan (your student loan) into a secured loan (a mortgage or home equity loan), you’re now potentially putting your home at risk. Is that worth it?
The Bottom Line
Whenever I counsel borrowers, I encourage them to think “big picture.” Are most of your loans federal private? How important is an interest rate reduction, and how likely are you to get it? How big of a risk is it to leave the federal loan system, and how can you mitigate these risks? What are the terms and conditions of the programs you are considering, and is there something that could jeopardize any financial benefits?
Knowledge is power, and the more facts you have about the student loan system, the better prepared you will be when making a major decision about managing your debt, and your future.
Adam S. Minsky, Esq. is an attorney with a practice devoted entirely to helping student loan borrowers. He practices in Massachusetts and New York.
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