The consolidation of private education loans can help you simplify and reduce your monthly payments. However, there are different ways to settle your debt. Learn the pros and cons so that you do not make matters worse and give up valuable benefits in your loan package.
Consolidation and Refinancing
Before you fill out an application, it is crucial to clarify a few details. You need to know if you have private student loans or federal student loans – or part of each. Then decide which loans to leave alone, and which to refinance or consolidate.
Consolidation is only available for federal student loans. This is confusing for students and graduates with private loans because “consolidate” debt: combining multiple loans into a single loan (that is possible with private student loans – when you refinance). Federal Direct consolidation loans allow combining multiple loans into one while retaining all the benefits of federal student loans. Your interest becomes a weighted balance of your existing loans, and you can opt for a new pay-off period.
Refinancing is available for private education loans and federal loans. When you refinance, you pay off existing debts with a brand new loan – ideally, the new loan is better than the loans you pay off. Technically, you are also consolidating when you combine multiple loans, but with private lenders, you cannot consolidate and maintain the same benefits that you get from government programs.
Consolidation of federal loans with its own Lender
Numerous private lenders are eager to consolidate any type of loan that you have, including federal student loans. However, once you move the federal loans from the Department of Education programs (and into a proprietary program), you will give up the benefits that come with federal student loans – your loans become private student loans.
Benefits of federal student loans include:
- Income-based reimbursement programs that keep payments affordable when your income is low
- Loan forgiveness, based on your career in public service or other factors
- Procrastination and forbearance: the ability to temporarily stop making payments in difficult times (some private lenders offer these functions, but they are usually less generous)
- Easier to qualify for certain loans with bad credit or no credit history (and without a cosigner)
- Subsidized interest costs while you are in school
- Fixed interest that could be lower than you can get on your own
- grace periods that do not require payments while at school
For more details, see the Department of Education explainer on private vs federal debt. You may not need these benefits, but you must at least know what is at stake.
Refinancing private loans
When you borrow from private lenders (also when you refinance), you must qualify for the loan based on your credit and income.
Credit scores are based on your borrowing history. Lenders want to see that you have successfully borrowed money and repaid other lenders. If you have taken loans in the past and you always pay on time, your credit must be in good shape. If you do not have a history of borrowing (or you have responded to loans), you must build up your credit history to qualify for the best loans.
Your income gives the money that you will use to make monthly payments, and lenders want to see plenty of disposable income every month. To determine whether or not you have the option to repay a new loan, private lenders use a debt to income ratio. The less you pay towards debt each month (including credit cards and car payments), the better.
If you are not eligible for a private loan based on your own credit and income, then you may be able to get the help of a cosigner. Cosigners request for a loan with you, signing their name on the loan agreement. Lenders will add income and credit information from your cosigner to the application, so cosigners with strong credit and lots of income are the best. Unfortunately, your cosigner takes a big risk by helping you out – if you make no payments on the loan, the creditworthiness of the cosigner’s will suffer, and lenders may try to collect the debt from both you and your cosigner.
When consolidating private loans, you can use any type of loan you want (as long as your new lender allows you to pay off private loans).
- Private student loan consolidation loans are meant for refinancing your private debt. Lenders offering these loans are willing to make large loans, but you have to qualify for the large payments (again, possibly with a cosigner). These loans can also offer borrowers functions as a temporary interruption of payments during unemployment.
- Personal loans from a bank, credit union, or online lender can be used for almost any purpose, including student loan repayment. With a personal loan, you don’t have to pledge collateral or use the money for a specific purpose.
- Home equity loans use your home to secure the loan. As a result, it would be easier to qualify, and you would get a lower interest rate. However, it’s risky to put your house on the line: if you can’t pay, foreclose your face (as well as credit damage). What’s more, mortgage loans, also known as second mortgages, often have expensive closing costs.
Why refinance? Why not?
Refinancing can help you save money and simplify your life, but it can also cause problems.
Higher costs are the biggest threat when refinancing private education loans. In addition to the application costs and closing, you would have more interest over the term of your loan if you refinance. Even if you have a lower rate on your new loan, a longer repayment period (for example, a loan that will be paid in 20 years instead of 10) can increase your costs. Before you make these payments, do some quick loan calculations and compare the costs.
Lower rates, if you can qualify, are useful. Especially if you originally borrowed with a private lender, there could be a chance to cut your financing costs. In recent years, your credit may have been improved, or new competitors may be eager to borrow at more attractive rates.
Fixed interest rates are predictable. If your loans have variable rates, you may be surprised if interest rates skyrocket in the future. However, with variable prices often start lower than fixed rates, and the rates might not really move much – only time will tell. If you get a low fixed price and you are concerned about the rising prices, refinancing can be useful.
If you used a cosigner to get approved, you would be able to refinance without a cosigner. This will get your friends and family off the hook and allows them to borrow elsewhere if they need to. But you wouldn’t need to refinance a cosigner removal – ask your current lender about a “cosigner release” if this is your top priority.
Lower payments are always nice, but they can come at a price. There are two ways to reduce your payment: use a lower interest rate or an extension of the repayment of the loan period (or both). If cash flow is a problem right now, you can definitely get some breathing room through the refinancing – just find out in advance if you are going to pay more interest in that comfort.
Fewer payments are easier to track. If you have loans from five different lenders, things can slip through the cracks. Refinancing and consolidation will turn five payments into one, but this may not be necessary unless you get additional benefits from the deal. These days, it’s easy enough to automate payments and let your bank deal with everything.
Private consolidation loans
If you have a remarkable amount of student debt, private lenders with a focus on education loans will probably end up at the top of the list. Because you are not using a government program, these loans are basically only personal loans branded as education loans. If you shop among the lenders, evaluate all the features below.
Interest: your rate is one of the most important features of your new loan. The higher your speed, the more interest you pay over the term of your loan. If you plan to aggressively pay the debt in just a few years, the interest rate is less important.
Help in difficult times: federal student loans offer help when you are unemployed or your income is low – you can stop paying temporarily without high costs or damage to your credit. Private lenders are not nearly as generous, but they can offer short periods of unemployment deferment and other benefits. Find out what’s available – just in case.
Criteria to qualify: banks can reject your application, but try other lenders. If you have a low credit score, some lenders are willing to look at alternative sources of information to determine your creditworthiness. For example, they can review your history of utility payments, or they can base the decision on your income and career.
Cosigner version: now, getting approved may be your main priority. If you are using a cosigner, try to use a loan with a clear policy that the cosigner releases the loan after you make some on-time payments. Your cosigner is your favor – and you can return the favor by reducing their risk. Of course, you plan to pay back, but accidents happen, and it’s best to remove cosigners as quickly as possible.