Student debt plagues the majority of college graduates every year. With tuition rates in the tens of thousands of dollars per year, students come out of school with years' salaries worth of debt. Whether that is federal student debt -- Perkins and Stafford loans (often referred to as Direct Loans) -- or private student debt -- various banks and private company loans -- debtors often find themselves struggling to make their payments. That is when student debt consolidation is important.
What Is Student Debt Consolidation?
Student debt consolidation is the process of taking out a new loan to pay off a group of other outstanding student loan balances. In essence, it simplifies your student debt by combining all your student loans into one loan. Student debt consolidators will provide you with lower monthly payments and interest rates, allowing you to pay off your entire balance over a longer period of time.
How It Works
For any student debt consolidation, debtors are required to have at least a $10,000 total due balance, but the debt consolidation process works differently for the two types of student loans.
Federal student loans are loans provided to students from federal sources and are based on income and general financial need. There are currently three types of federal student loans: Perkins, Stafford and PLUS Loans. With lower interest payments than private loans, they also have a six-month grace period for repayment following graduation.
Private student loans come from private organizations, most commonly banks and large corporations like Sallie Mae. They are based on credit eligibility, and often have higher interest rates. Repayment commencement varies from organization to organization. Private student loans cannot be consolidated through federal consolidation programs.
Federal student loan consolidation, like federal student loans, has more benefits to the debtor than do private student loan consolidations and private student loans. Through the Federal Consolidation Loan Program, debtors to federal student loans can consolidate these loans into one new loan that has one monthly payment, flexible repayment options and carried-over grace and deferment benefits. Should you consolidate your federal loans and become permanently disabled, deceased, or go back to school, you still qualify for dismissal and deferment options available to original federal debtors.
Federal student loan consolidation is often referred to as refinancing, but that nomenclature is technically incorrect. Refinancing refers to redrawn rates, and this does not occur with federal student loan consolidation. Rather, the rates are locked in and will not change over time. Federal student loan consolidation can also increase your credit score, because it has the potential of raising your income-to-loan ratio. Federal student loan consolidation also does not require a credit check or a co-signer.
Private student loan consolidation works more similarly to regular debt consolidation than to federal student loan consolidation. They do require a credit check and, generally, a co-signer. By working with private refinancing organizations, people with private student loan debt can combine their loans into one pot, with a lowered interest rate and a pre-arranged payment plan. Like with regular debt consolidation, however, the risks should be assessed carefully. Read your consolidation contract carefully before signing, keeping an eye out for hidden charges and assessment fees. Also, try to avoid consolidation plans that have penalty fees for early repayment. Should your financial situation change, it will be in your best interest to pay off your balance sooner, so you always want that option to be available to you.
Consolidating all your student debt -- federal and private -- together is always an option, but it is a very poor one. By privately consolidating federal loans, you lose any benefits that were originally tied to them, including the deferment options listed above. If anything, consolidate both your federal and private student loans, but do it separately in order to retain your benefits.
So It's Time to Consolidate
After considering the options, it is time to consolidate. If you have both federal and private student loans, listen carefully. Do not consolidate your debt together. Federal student loans and their consolidation process were put together carefully by the Department of Education to ensure that students have fair and fixed interest rates, repayment options and deferment options in case of extreme personal distress. Do, however, consolidate your debt, but do it separately. Federally consolidate your federal student loans, and privately consolidate your private student loans.
When doing this, always consolidate your federal student loans first. This can better your credit score by increasing your income-to-loan ratio, which will, in turn, make you eligible for a lower interest rate on your private loan consolidation. Of course, always use the resources available to you. Student loan companies commonly offer free debt counseling to discuss payment options, debt management and further debt consolidation information.
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