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10 Common Student Loan Consolidation Myths Debunked

If you’re one of the millions of Americans who’ve graduated with student loan debt, you’ve likely got more than one student loan. That could mean making multiple monthly payments with multiple due dates to multiple student loan servicers or lenders. Thus, it could be easy to lose track of payments or have trouble managing your monthly bills. One option to make things easier is student loan consolidation.

A federal direct consolidation loan combines your federal student loans into a single new loan with one monthly bill. There are advantages to consolidating your student loans, but there are also a lot of misconceptions. Before making any moves with your student loans, ensure you understand what you’re getting into and don’t buy into any of these common myths.

Common Student Loan Consolidation Myths

When deciding whether or not to consolidate, it’s crucial to make the right financial decision. These loans will be with you for a while. Don’t fall for any of these common student loan consolidation myths.

Myth 1: Consolidation Is the Only Way to Pay a Single Bill Every Month

The primary purpose of consolidating your student loans is to have only one bill to pay every month. Consolidation lets you replace multiple student loans with one new loan, the federal direct consolidation loan. The consolidation loan pays off your old loans. So you now make only one monthly payment to the consolidation loan under your chosen federal repayment plan.

But it’s not the only way to get a single monthly payment. The United States Department of Education (ED) already ensures one servicer (the company that manages your payments on behalf of the ED) handles all a borrower’s student loans in most cases. And servicers generally send one bill with one due date, even if they’re servicing multiple loans.

Plus, even if you have loans with more than one servicer, payment options like the ability to schedule automatic payments make managing multiple bills easier. Thus, if you can afford the payments, there’s no need to consolidate.

Myth 2: Student Loan Consolidation Is the Same as Student Loan Refinancing

Although similar, student loan refinancing and consolidation aren’t the same. Both involve taking out a single new loan, but that’s where the similarities end. There are far more differences than similarities between the two. For example:

  • The ED issues federal direct consolidation loans. Student loan refinancing is only offered through private lenders, such as banks or credit unions.
  • You can refinance a single loan. But for federal consolidation, you must have more than one loan.
  • You can theoretically refinance an infinite number of times. But you can only consolidate once unless you have new loans to add.
  • With consolidation, your interest rate doesn’t change. With refinancing, you can get a lower interest rate.
  • You can’t consolidate private student loans with a federal direct consolidation loan. But you can include federal student loans with private student loan refinancing.
  • If you refinance federal student loans, you no longer have access to federal benefits since you no longer have federal student loans. Federal student loan benefits include federal repayment plans, student loan forgiveness, deferment and forbearance options, and borrower protections like loan discharge in cases of total and permanent disability.

See our article on the advantages and disadvantages of consolidation versus refinancing for more information.

Myth 3: You Can Consolidate Federal and Private Loans Together

Only federal student loans are eligible for consolidation with a federal direct consolidation loan. You can’t consolidate private student loans through the ED.

If you need to combine federal and private student loans into a single loan with one monthly payment, you must refinance.

But you have to carefully consider whether doing so is worth it before going this route. If you refinance your federal student loans, you lose access to federal repayment options like income-driven repayment. You also lose the ability to have your loan balance forgiven through federal programs like the Public Service Loan Forgiveness Program.

Additionally, private lenders have significantly less generous deferment and forbearance terms if you need to suspend payments for economic hardship or to attend grad school.

Refinancing federal student loans can still be worth it if you can get a significantly lower interest rate. That’s especially true if you have several high-interest-rate student loans like grad PLUS or parent PLUS loans.

But it’s vital to consider the risks of refinancing before you sign. Once you convert your federal student loan debt to private debt, there’s no going back.

Myth 4: You Need Excellent Credit to Consolidate Your Loans

If you’re worried you need a good credit score to consolidate your student loans, rest easy. The ED doesn’t check your credit at all. So even if you have poor credit, you automatically qualify.

The only eligibility requirement for a federal direct consolidation loan is qualifying federal student loans. That is, your loans must be in active repayment status or the pre-active status grace period, meaning you’ve graduated or dropped below half-time enrollment.

In fact, you can consolidate federal student loans even if you’ve defaulted on them. Consolidation is one of two options for bringing your defaulted student loans back into good standing.

However, you do need good credit to refinance student loans. And only the most creditworthy borrowers qualify for the best interest rates.

Myth 5: Consolidating Your Loans Reduces Your Interest Rate

The idea that consolidation can lower your interest rate is one of the most common student loan myths. But consolidating your student loans can’t score you a better interest rate.

To determine your new rate, the ED takes the weighted average of the interest rates on your current loans and rounds that up to the nearest one-eighth of 1%.

A weighted average means that instead of adding everything up and dividing by the total number of loans, some things are given more importance than others. The interest rates on your larger loans are given more importance than those on your smaller loans.

For example, let’s say you borrowed a $5,000 Perkins loan with a 5% (0.05) interest rate and a $10,000 unsubsidized federal direct loan with a 3.86% (0.0386) interest rate. To find the weighted average, the math would look like this:

[(5,000 x 0.05) + (10,000 x 0.0386)] / (5,000 + $10,000) = 0.0424

The weighted average is then rounded up to the nearest one-eighth of a percent, so you get a final interest rate of 4.25%.

Rates for consolidated loans generally even out. The formula’s purpose is to keep your overall interest rate effectively the same.

Unfortunately, there are very few things that can lower the interest rate on your federal student loans. You’re pretty much stuck with whatever it is for the life of your loans.

Myth 6: Consolidation Is the Only Way to Get a Fixed Interest Rate

Up until 2006, federal student loans came with variable interest rates. If you consolidated when rates were low, it could save you money over the life of your loan. So before 2006, consolidation was a common practice.

But in 2006, the government fixed interest rates for the life of federal loans. Now all federal student loans are fixed-rate loans. So you don’t need to consolidate to get a fixed rate. Nevertheless, this student loan myth persists.

It’s still possible to get a variable interest rate with private student loan refinancing. Typically, the variable interest rates on a refinance loan are the lowest. That’s because a variable rate is always a risk. They fluctuate with market conditions. That means they could end up higher than the rate on your old loans.

But fixed rates also come with pros and cons. If interest rates skyrocket after you graduate, you don’t have to worry about yours going up. But if you borrow your student loans during a high-interest year, you’re stuck with that rate. The only real way to change the interest rate on a federal student loan is to refinance it into a private student loan.

That’s because Congress sets federal student loan interest rates. They base it on the 10-year Treasury note rate as determined by the high yield from the annual May auction plus a fixed percentage, depending on the loan type.

Fortunately, federal interest rates have been relatively low over the past decade, ranging from 3% to 5%. But federal Stafford loans for undergraduate students had interest rates as high as 8.19% in 2000-01 and 8.25% in 1997-98.

The Student Loan Certainty Act of 2013 established a cap of 8.25% on undergraduate loans and 9.5% on graduate loans. But even that cap means it’s possible interest rates could rise that high again.

So if you have old student loans with variable interest rates and you never consolidated them, now’s the perfect time to do it — while federal student loan rates are still relatively low.

Myth 7: Consolidation Will Save You Money

Student loan consolidation can simplify repayment and lower your monthly payment. But it can’t save you money on the overall cost of the loan. Remember, your interest rate won’t change. In fact, it will increase slightly because the weighted average formula rounds it up to the nearest one-eighth of 1%.

Further, when you apply for consolidation, the application asks you to choose a student loan repayment schedule. That could be as short as the standard 10-year plan. But most borrowers opt for one of the other plans, which can extend your payments up to 30 years. CNBC reports on a handful of studies that show the average student loan borrower takes 20 years to repay their loans.

No matter how low an interest rate you get on your loans, if you extend the loan term, you end up paying back more in total.

For example, the interest rate on federal direct student loans for undergraduates for the 2021-22 academic year is 3.73%. If you borrowed $27,000, the full amount allowed for undergraduate college students over four years, and repaid it over 10 years, your loan would cost $32,389. But if you took 20 years at the same interest rate, it would cost $38,352.

That said, extending your repayment term can significantly lower your monthly payment. For example, paying back your $27,000 loan on a 10-year schedule gives you a monthly payment of $270. But paying it back over 20 years reduces it to $160.

If you have trouble managing your monthly payment, consolidation can help stretch a tight budget. But you won’t save money. In fact, it could cost you much more in the long run than just the price of interest.

Numerous studies, including a 2019 report on the impact of student loans from the AgeLab at the Massachusetts Institute of Technology, have shown that student loan debt significantly impacts borrowers’ ability to save and invest.

Especially when it comes to putting aside money for retirement, the years you make student loan payments instead of saving can severely impact your nest egg.

For example, common wisdom says average historical stock market returns are 10%. But adjusted for inflation, they’re closer to 7%. Using that more conservative estimate, if you invested the $270 student loan payment over 10 years, you could have about $44,765 at the end of the repayment period.

More significantly, if you started investing the same amount as your payment right after graduation at age 22, stopped at 32, and kept it in the market until you retired at the age of 67, you could have $477,937, even if you never invested another cent. And if you kept investing for the full 45 years, you could have almost $1 million.

But if burdensome loan payments leave you unable to invest anything for all those years, you won’t end up with those kinds of returns. For example, at the same average 7% return, if you don’t start investing your $160 per month until after you pay off your student loans on a 20-year repayment term, you’ll only end up with about $121,438 at age 67. That’s a potential loss of almost half a million dollars in retirement savings.

In some cases, it makes sense to reduce your payment so you can prioritize investing over paying off your debt. But it’s probably best to get rid of your student loans as quickly as possible.

For example, if every month you invested the $90 difference you’d gain by extending your repayment term to 20 years, you could have $44,275 at the end. Once you’re finished making payments, you could invest the whole $270 for your remaining 25 working years and end up with $445,226.

Or you could pay off your student loans in 10 years and be free of them. If your $270 monthly investment averages a 7% return for 35 years, at age 67, you could have $447,887 — about the same.

But if you’re struggling to make your payments, income-driven repayment may be your best option. Under these programs, your payments are based on your income. And you could have your remaining loan balance forgiven in as little as 10 years if you work in a public sector job.

Myth 8: There Is a Fee to Consolidate Student Loans

There are plenty of unscrupulous companies that will charge you a fee to consolidate your loans for you. But there’s no need to pay anyone. It’s free to do it yourself. The application for a federal direct consolidation loan is available online at Federal Student Aid. It only takes about 30 minutes to complete.

Never pay a company that asks you to pay a fee for applying for student loan consolidation on your behalf. It’s a common student loan scam. And if you find yourself at a website asking for a fee to submit an application to consolidate your federal student loans, know you’re in the wrong place. The ED doesn’t charge for this service. Even the best private refinance lenders don’t charge application fees.

Myth 9: You Have to Consolidate to Qualify for Forgiveness

Many borrowers believe they need to consolidate their loans to qualify for federal student loan forgiveness programs. But the only general requirement for your loans to qualify for forgiveness is that you must enroll them in an income-based repayment plan.

You may need to consolidate some loans to make them eligible. These include older loans from discontinued federal programs like Perkins loans and Stafford loans. Those programs expired in 2017 and 2010, respectively, and were not federal direct loans.

Consolidating those loans turns them into federal direct loans. That makes them eligible for the income-based programs you need to enroll in to qualify.

Myth 10: Consolidation Is a Good Idea for All Borrowers

Although student loan consolidation makes sense for many borrowers, it’s not the best move for everyone — or every loan.

For example, if you have parent PLUS loans and you consolidate them with your other student loans, you only qualify for one income-driven repayment plan — the one with the worst terms. It calculates your monthly payment as the highest percentage of your discretionary income, capitalizes your interest annually, and keeps you stuck in repayment for 25 years.

If you have a Perkins loan, you need to consolidate it to qualify for income-based plans and make it eligible for forgiveness. But Perkins loans have many forgiveness and cancellation programs of their own, especially for certain professions. So if you consolidate it, you no longer qualify for Perkins loan cancellation or discharge.

And if you consolidate a loan you’ve been paying under an income-based plan, you lose the progress you’ve made toward forgiveness and will have to start over at square one. Again, that’s because you have a brand-new loan. The old loan you’ve been paying no longer exists.

These are just a few of the reasons consolidation doesn’t make sense for all loans or borrowers.

Final Word

Understanding what student loan consolidation can and can’t do for your student loans is vital.

If you’re consolidating to make multiple payments easier to stay on top of, there may be better options for you. That’s especially true if you have loans that are better off remaining unconsolidated, such as parent PLUS or Perkins loans.

And paying multiple loan bills each month isn’t impossible. For example, you can make a monthly budget using a budgeting app like Tiller or Mint. Seeing all your recurring bills in one place can help ensure you make all your payments on time.

If you’re consolidating because you need a lower monthly payment, explore income-driven repayment plans. Just don’t get trapped in a cycle of ongoing debt. It’s easy to forgo savings when you’re living paycheck to paycheck. But you’ll miss out significantly if you don’t invest in yourself while you’re paying off student loan debt for what could potentially be decades.

Fortunately, there are plenty of options for micro-investing. Micro-investing lets you invest tiny amounts, including your spare change. And even pocket change can become something substantial when allowed to grow over time.

Check out micro-investing apps like Acorns, Stash, Robinhood, or Ellevest to help build your nest egg or emergency savings while you’re paying off student loans.

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.