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Consolidating vs. Refinancing Your Student Loans – Which Is Better?

No matter where you went to college, one thing most graduates have in common is a significant amount of student loan debt. Trying to manage it all can feel overwhelming regardless of your financial situation.

Whether you’re looking for a way to stretch a tight budget or pay off your loans faster, consolidation or refinancing could help. But before you make any moves with your student loans, it pays to know which option can benefit you the most.  

Consolidating vs. Refinancing Your Student Loans

Student loan consolidation and refinancing are both ways to combine several student loans into a single loan with one monthly payment. Essentially, you take out one large loan that pays off all your current loans. 

The primary difference is who gives you the loan. Student loan consolidation refers to taking out a federal direct consolidation loan from the government. Student loan refinancing involves getting a loan from a private loan company, such as a bank or credit union.

If your original loan is already through a private loan company, refinancing is your only option. The federal government only consolidates its own loans, and private lenders “consolidate” through refinance loans.

But the differences don’t end there. Consolidation and refinancing also operate differently and have different perks and drawbacks. Thus, which is best for you depends on your goal. 

You Want Access to Loan Forgiveness: Consolidate 

If you’re planning to take advantage of the government’s federal student loan forgiveness programs, don’t refinance. Once you refinance a federal student loan, it’s no longer a federal loan. 

There are two student loan forgiveness programs: 

  • Standard forgiveness of any remaining loan balance after making 20 to 25 years of payments on an income-driven plan 
  • Public service loan forgiveness, which forgives your loan balance after 10 years of qualifying payments

You must enroll your loans in an income-driven repayment plan to be eligible. However, you don’t necessarily have to consolidate them unless you have older FFEL (Federal Family Education Loan) Program loans or Perkins loans, which you must consolidate to qualify. 

That said, if you’ve already made progress toward forgiveness on some loans, don’t consolidate them with your other student loans. Consolidation effectively wipes the slate clean (since it’s a new loan), and the clock restarts at zero. But you can consolidate the rest.

Private loans aren’t eligible for forgiveness. 

You Want to Pay Off Your Loans Faster: Refinance

Generally, refinancing has a slight edge if you want to repay your loans faster. Because refinancing typically lowers your interest rate, it also reduces your monthly payment.

But if you keep making the same payment as before you refinanced, you can knock out your loan balance even faster

For example, you would make your last payment on a $40,000 loan paid back at 3% interest with a $464 monthly payment in just over eight years rather than the 10 it would take if you stuck with the $386 minimum payment. 

Consolidation can keep you in debt far longer. Since your interest rate stays the same, consolidating doesn’t free up any additional cash to pay down your loans quickly. You can only pay off your loans faster with consolidation if you have the cash to pay more than the minimum monthly payment.

And though you can certainly stick to the standard 10-year repayment schedule, most borrowers opt for a longer repayment term, 20 to 30 years on average. 

But if you plan to work a public sector job, crunch the numbers first to make sure public service loan forgiveness isn’t a better option. Two extra years may be worth it if you could save thousands of dollars.

You Want to Save Money: Refinance (if You Qualify)

If your goal is to save money, refinancing could offer you the better option over consolidation under the right circumstances. 

It’s a common myth that consolidation lowers your student loan interest rates, but it doesn’t. Your interest rate stays roughly the same, so you can’t save money by consolidating.

In fact, consolidation might cost you money. Any outstanding interest capitalizes (becomes part of the principal balance) when you consolidate student loans. That means you start earning interest on the new higher balance — or interest on top of interest.

Refinancing is all about scoring a lower interest rate. Depending on how much you owe, that can help you save thousands or even tens of thousands over the life of the loan. 

For example, if you borrowed $40,000 on a 10-year repayment plan at 7% interest, you’d pay back $55,732. But if you refinanced at a 3% interest rate, you’d pay back a total of $46,349 over those same 10 years — a savings of almost $10,000. 

But there are two catches. First, you must have a good credit history to score the lowest interest rates. Additionally, most refinance lenders require a minimum credit score of 680 just to get a loan. So to get the best rates, your score needs to be significantly higher. 

If you don’t know your score, check your credit report. If your score is too low, applying with a co-signer can help.

Private lenders also typically require borrowers to have a job that pays enough to repay the debt. Thus, refinancing is only for borrowers in an excellent financial position. It’s not for struggling student loan borrowers. 

And if your financial situation ever changes for the worse, catch No. 2 will get you. Refinancing your federal loans with a private lender robs you of the protections that come with federal loans, such as generous deferment and forbearance terms. 

Plus, some borrowers can save more money by taking advantage of public service loan forgiveness, which forgives your balance after you make 10 years of qualifying payments. 

For example, say you borrow $140,000 to get a law degree. You become a public defender earning around $60,000 per year and repay under the public service forgiveness program. You could end up paying back just under $54,000 of your student loans. And the government would cancel the rest.

You lose that option if you refinance. Thus, a better interest rate isn’t worth it.

You Want to Lower Your Monthly Payments: It Depends

If you’re struggling, lower monthly payments can help make ends meet. Both refinancing and consolidation can help lower your payment, but in different ways.

Refinancing lowers your payments by reducing your interest rate. For example, using the same numbers as above, $40,000 paid back over 10 years at 7% interest is a monthly payment of $464. At 3% interest, the monthly payment becomes $386.

Additionally, you can opt for a longer repayment term when you refinance. That lowers your monthly payment even further. Most lenders allow you to extend your loan to 15 or 20 years. Some even offer 25-year terms. Just note that raises your interest rate, meaning you pay more for the loan overall.

Plus, you lose federal borrower protections and perks like generous forbearance and deferment terms if you refinance.

Consolidation also gives you the option to extend your repayment term — up to 30 years, depending on the amount you owe. Thus, a $464 monthly payment paid back over 10 years could become a $266 monthly payment if paid back over 30 years.

Additionally, all of the income-driven repayment plans, which you can choose from when you consolidate, tie your monthly payment to a certain percentage of your income. 

So if you become unemployed or experience a period of reduced income, you could potentially make loan “payments” as low as $0. And while those payments don’t reduce your principal balance, they do count toward programs like student loan forgiveness.   

One word of caution: Interest racks up over a longer period, so you end up paying back far more than if you’d stuck to the 10-year repayment schedule. 

For example, if you paid it back over 30 years rather than 10 years, the $40,000 loan would end up costing you over $55,000 extra — more than double what you borrowed.

Even if you’re on an income-driven repayment plan, which forgives federal student loans after 20 to 25 years of income-based payments, you could still pay a few thousand more in interest, depending on your annual salary and the plan you qualify for. 

But if your current monthly payment is straining your budget, extending the repayment term — whether through refinancing or consolidation — can give you more breathing room. And you can always make larger payments when your income increases. 

You Want to Combine Private and Federal Loans: Refinance 

Though relatively rare, some students leave school with a mix of several federal and private loans. That quickly becomes complicated, as you end up with several monthly bills, all with different minimum payments, due dates, and potentially even lenders and loan servicers (companies that manage your loans on behalf of the government).

Federal student loan consolidation lets you combine your federal student loans. But you can’t consolidate private loans with a federal direct loan.

Refinancing lets you combine your federal and private student loans into a single loan. The lender gives you money to pay off your federal loan and any other private loans you have. Then, you have only one monthly payment to one company. 

However, remember that refinancing your federal student loans means losing access to federal repayment programs and perks like generous deferment and forbearance options and loan forgiveness.

Even if you don’t think you’ll need these federal benefits, the future is uncertain. Thus, it’s generally best not to refinance federal student loans unless you’re fully committed to paying off your loans as quickly as possible and have a high income and an emergency fund.

And even then, if refinancing doesn’t substantially lower your interest rate, it’s probably not worth it. You can always pay more than you owe to pay it off faster. Just ensure you tell the student loan company to put any additional funds you send toward your principal rather than the next payment.  

You Want to Keep Your Options Open: Consolidate

You may intend to pay off your loans quickly and may go into refinancing with a well-paying job. But no one knows what the future holds. If you refinance your student loans with a private lender, you may save money, but it also closes a lot of doors.

Once you refinance with a private lender, you no longer have a federal loan. And there’s no going back. So it’s vital to be aware of what options you’re losing.

The federal government offers options if things don’t go as expected. And that doesn’t always mean job loss. You may want to be able to take a pay cut for a job with better working conditions or leave the workforce to care for your family. 

Similarly, if you want to make other life choices, like going to grad school, the government has generous deferment and forbearance terms. 

Many private student loan companies offer deferment for things like academic reenrollment, financial hardship, and military deployment as well as forbearance options for temporary financial difficulties. But the periods are typically much shorter than those for federal loans. 

Federal student loans also come with a lengthy list of borrower protections. These include discharge or cancellation of your student loans due to:

  • The borrower’s death or the death of the student on whose behalf the loan was borrowed (in the case of Parent PLUS loans)
  • The total and permanent disability of the borrower
  • The school closing before you’re able to complete your degree
  • The school’s failure to either pay out or return your federal loan money
  • An act of fraud committed by the school, such as falsely certifying a loan in your name
  • The school’s misrepresentation of your ability to benefit from the program
  • Bankruptcy

Most private lenders don’t offer these protections. 

Final Word

As with anything, when determining which option makes the most sense for you, it’s essential to consider all the angles carefully. Does it make more sense for you to pay off your loans quickly so you can start saving for a down payment on a house? Or maybe you just need a way to help make ends meet?     

To help you decide how consolidating or refinancing could affect your personal finances, enter your federal student loan amounts and interest rates into the loan simulator at Federal Student Aid for information on how a consolidation loan would affect you. 

Then head over to Credible to see what kinds of refinance deals you could qualify for. It matches you with prequalified rates without affecting your credit score or locking you into a commitment. Even if you don’t opt for one of those loans, it gives you a good idea of where you stand.

Then you can use Credible’s student loan simulator to compare those private options to your federal ones. 

Sarah Graves, Ph.D. is a freelance writer specializing in personal finance, parenting, education, and creative entrepreneurship. She's also a college instructor of English and humanities. When not busy writing or teaching her students the proper use of a semicolon, you can find her hanging out with her awesome husband and adorable son watching way too many superhero movies.