When Should You Consolidate Your Loans With The Federal Government?

By | February 2, 2017
when should you consolidate your loans with the federal government

Federal student loan borrowers have the option consolidate their loans through the federal government or a private lender. As with any decision, there are tradeoffs with either option. This information can help you determine whether you should federal or private consolidation with your student loans.

How Does Federal Student Loan Consolidation Work?

A Direct Consolidation Loan only includes federal student loans and are administered by the U.S. Department of Education. This means private student loans can only be consolidated or refinanced through a private lender. Most forms of subsidized and unsubsidized federal loans qualify for the direct consolidation loan program and here are a few key points to understand how they work:

Interest Rate is a Weighted Average

The federal consolidation interest rate isn’t based on your credit score or new repayment terms. It is solely based on the average interest rate of the loans you wish to consolidate. So, if you have a loan with a low-interest rate (3.86%) it’s not possible to reduce the rate any lower through the federal government. As the federal programs round the rate up to the nearest one-eighth percentage point, the rate will most likely be slightly higher than your current average interest rate.

Interest rates are fixed for the life of the federal consolidation loan.

Repayment Terms Range from 10 to 30 Years

One of the primary reasons to consolidate your loans is to extend the repayment terms up to 30 years to allow more time to repay the loan balance. This can be beneficial if you are currently struggling to make the current monthly payment.

Federally Consolidated Loans Retain Repayment and Forgiveness Options

You will need to read the fine print of your federal loans to be certain, but, most federal loans are still eligible for the various loan forgiveness programs such as the Public Service Loan Forgiveness program that forgives the remaining loan balance after 10 years for government and select non-profit employees.

These loans still also qualify for the several income-driven repayment plans that limit payments to 10% of a borrower’s monthly income. Most forbearance and cancellation benefits are still retained as well when consolidated through the U.S. Department of Education. These benefits are forfeited when consolidating with a private lender.

How Do Private Lenders Consolidate Federal Student Loans?

A second option to consolidate federal loans with a private lender. There are a few key differences that you should know about that might be more advantageous than consolidating through the Department of Education as private consolidation loans are very different.

Potentially Lower Fixed or Variable Interest Rates

Private lenders can offer you a potentially lower interest rate than your current federal interest rate. Your new interest rate is based on your loan balances, repayment period, your credit score, and whether it’s a fixed or variable interest rate. In a nutshell, you will get the lowest rates when you choose the shortest repayment term (i.e. 3 years instead of 15 years).

Variable rates will offer you the lowest interest rates as they currently range from 2.345% to 6.270%. Applying for a variable rate is recommended if you plan to repay the entire balance within the next 3 to 5 years. This is because the rate raises and lowers as the key banking interest rates vary. A sharp rate increase can make a variable rate more expense than a fixed rate loan because of the volatility.

Fixed interest rates currently range from 3.375% to 6.740% and will remain the same for the life of the loan just like the Federal Direct Consolidation Loans. While variable rates offer the highest potential cost savings, it is still possible to get a lower fixed interest rate than your current average federal interest rate.

Federal and Private Loans Can Be Combined Together

One reason people pursue private consolidation and refinancing is to have all their loans merged into a single account with one due date and interest rate. When consolidating through the Department of Education, only federal loans can be consolidated in a Direct Consolidation Loan.

Private Consolidation Forfeits Federal Repayment and Forgiveness Options

The largest potential downside when consolidating federal loans through a private lender is that you have to forfeit the repayment and forgiveness options exclusive to federal student loans. This means that if you currently use or plan to use an income-based repayment plan, a loan forgiveness option like the PSLF program for government and non-profit employees, or will be requesting a deferment or forbearance, you can no longer pursue these options when using a private lender.

Some private lenders do offer deferment requests, however, they are not as generous as the federal benefits. If you want to keep your repayment options open, private lenders have a hard time competing with the Department of Education.

Which is the Better Option?

When deciding whether to consolidate your federal loans through the federal government or a private lender you need to determine your primary reasons for consolidating.

A Direct Consolidation Loan from the U.S. Department of Education is the better option if you want to keep the federal loan repayment and forgiveness options available for future use. If you have fair credit or need to extend your repayment period, the federal weighted average might be lower than the private rate.

If you want a lower interest rate and do not need the repayment or forgiveness options, using a private lender is the better option. Plus, you can also combine your private student loans with this option to make your monthly loan payment even more convenient.

A final option is to not consolidate at all. This is most likely if your current interest rates are already low or you do not have trouble making the monthly payment. Plus, you still know you have the additional repayment and forgiveness options if you need future access to them.


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