A student loan consolidation takes the borrower’s loans and combines all the loans into one new loan with one lender, and one weighted average interest rate. This removes the burden from the borrower of trying to keep track of many different loans, with different lenders, balances, and interest rates. Consolidation programs exist for both federal and private student loans, but the purpose of this page is to discuss federal student loan consolidations.
William D Ford Direct Loan Consolidation Program
President George H.W Bush first passed the Direct Loan program in 1992, as an amendment under the Reauthorization of the Higher Education Act. Although the program existed since then, it was not until President Obama’s budget in 2010 switched all new student loan lending over to the Direct Loan program. This is part of the reason why many people refer to it as the Obama Student Loan Forgiveness program.
The Direct Loan program now has a $1 trillion dollar balance, with a yearly increase in the hundreds of billions of dollars being lent to students.
Benefits of the Consolidation
There are quite a few good reasons to consider consolidating your federal student loans. Understanding all the benefits will help you make a good financial decision. Here is an overview of some of the many benefits:
- Having only one federal loan under your name, with one lender, and one interest rate will greatly simplify your student loans. You will be able to track this student loan balance on one monthly bill. No more paying many bills to many lenders, and not knowing the combined balance of all your loans on one single statement.
- Consolidation offers flexible repayment plans. You can enter into a payment plan that fits your needs, with payments even as low as $0.00 per month depending on your income and family size. This is not a deferment or forbearance, it’s actual payment of $0.00 per month if your income is so low that the government says you cannot afford to make payments. Payment plans are also not written in stone as with a normal loan. If for example you are currently able to make your payments without a problem, but in the future lose part of your income, you will be able to change your repayment plan with no other adjustments to your loans being necessary. This offers the borrower to have flexibility with the monthly payment, and not fall into default when unemployed, or earning less than what he or she is able to pay the most necessities with.
- Consolidation also has various loan forgiveness aspects that may not be available with your current loans.
- After paying on your loans for 20-25 years, any remaining balance on your federal student loans is forgiven. This could be a very sizable amount.
- Interest in the IBR repayment plan is forgiven on the subsidized portion of your loans for the first three years if your monthly payment is less than the interest that should be accruing.
- Consolidated loans are eligible for the Public Service Loan Forgiveness program.
- Consolidation also takes any defaulted loans you have out of default and puts them into good standing with a fresh start. This gives the borrower a second chance, combined with the flexible repayment plans it makes falling back into default difficult unless the borrower is not pro-active with the loans, and takes an “I do not care” attitude towards them.
- Interest on the loan is exactly what your current interest is on all your loans. This means you do not have to worry about the interest rate, no negotiating, no hassle.
Reasons To Not Consolidate.
Consolidation may not be the best option for everyone. What is the most important is to become educated about your loans, what programs exist to help you, and then to take action on what you determine to be the best for your particular situation?
Here are some reasons you may want to consider not consolidating your loans:
- Consolidation will in some cases extend the life of your loan. If you can afford your payment and want to get the loan paid off as fast as possible, consolidation may not be for you.
- When your loans are consolidated, they are converted into Direct Loans. At that time, you will lose any benefits of your old loans, but gain the benefits of the Direct Loans.
There are several repayment plans the borrower can choose to take advantage of in the new consolidated loan. The Income-Based Repayment and Pay As You Earn are often the most beneficial for those with financial difficulties.
Weighted Average Interest Rate
The Direct Loan Consolidation program uses a weighted average interest rate to calculate your new interest rate in the consolidation rounded up to the nearest one-eighth of 1%. This method takes the average weight(balance) of your loans as compared with the interest rate to give you a new fair interest rate.
Example: Borrower has a balance of $100,000 on their federal student loans that is split into two different loans. One loan is $25,000 @ 6.5% interest, the second loan is $75,000 @ 3.5% interest. Because the loan with a $25k balance makes up 25% of the borrowers’ balance, they would multiple 25% x 6.5% = 1.625%. Next, the remaining $75k balance makes up 75% of the borrowers’ total balance, so they would multiple 75% x 3.5% = 2.625%. The Department of Education would then combined those two numbers to come up with the weighted average interest rate of 1.625% + 2.625% = 4.25%.
As you can see from this example, the borrower had not one but two interest rates which have now been combined into one interest rate that takes the balance(s) of the loan into consideration when calculating the new and fair weighted average interest rate.
How Long Does It Take To Consolidate
The length of time required to complete the consolidation depends largely on the borrower and the federal servicer. Once the borrower has signed all the necessary paperwork and has submitted it to the lender, it typically takes between 30-60 days for the loans to be consolidated and paid off.
Loans That Are Eligible For Consolidation
Only federal student loans are eligible for this consolidation; private loans are excluded entirely. The loan types which qualify for a consolidation are:
- Direct Subsidized.
- Direct Unsubsidized.
- Federal Perkins Loans.
- Plus Loans.
- Stafford Unsubsidized.
- Stafford Subsidized.
- Supplemental Loans for Students(SLS).
- Federal Nursing Loans.
- Health Education Assistance Loans.
- FFEL Loans (must be consolidated with another loan, or applying for PSLF).
When Can I Apply For Consolidation?
Generally, you can apply for consolidation once you have graduated from school, or have left school, or have dropped below 6 credits per semester. Your student loans would need to show that they are not in “FULL TIME” status, and must be in repayment. There is no cost to applying for consolidation if you plan on applying on your own through the Department of Education.