The direct consolidation of federal student loans is not easy to control. For some borrowers, consolidation is an essential step in getting rid of their student debt. For others, federal consolidation would be a grave mistake. Deciding whether or not to perform a consolidation is an essential step in planning a repayment strategy.
In general, federal student loan consolidation is most helpful for borrowers trying to resolve eligibility issues. Some borrowers can take advantage of consolidation to qualify for student loan origination or income-based repayment plans.
Today I’m going to cover the basics of federal direct consolidation and share a ton of tips on how to get the most out of it.
What is Federal Student Loan Consolidation?
At the simplest level, a federal student loan consolidation combines multiple federal loans into a single loan.
However, in order to understand the multiple rules and fine print of student loan consolidation, it is easier to look at them from a different perspective.
The federal consolidation converts an old federal loan into a new federal loan. Usually the process involves combining multiple loans into a single new loan. However, borrowers have the option to consolidate a single loan.
The emphasis on “transformation” is there because the process can be either good or bad. Some borrowers go wrong and turn a loan they might like into a bad one. Other borrowers use consolidation wisely, converting a bad loan into a better federal loan.
What makes a good or bad credit depends on the perspective and the circumstances. The best way to explain how this transformation can be used is to give some examples of what to do and what not to do.
When should federal student loans be consolidated?
The classic example of smart use of federal direct consolidation is the Federal Family Education Loan Program (FFELP). Until 2010, FFELP loans came from private lenders, but they were guaranteed by the federal government. These loans worked primarily like federal student loans, but had some limitations.
In particular, FFELP loans are not eligible for public loans. However, the consolidation of federal student loans will convert FFELP loans into a “federal loan”. As government-held loans, the new loans are eligible for student loan allocation.
Another example of a potentially smart use of consolidation is Parent PLUS loan consolidation. One of the major problems with Parent PLUS loans is that they are not eligible for an earnings-based repayment plan. Likewise, they do not qualify for public lending. However, by consolidating into a direct federal loan, the Eltern-PLUS loan can be considered for the income-based repayment plan and the granting of student loans.
What makes these two consolidations smart is the fact that a federal program limited-eligibility loan has been converted to a new, better-eligibility loan.
However, this transformation isn’t always a wise idea.
When is Federal Student Loan Consolidation a Big Mistake?
The classic example of federal student loan consolidation is a big mistake when a borrower combines a Parent PLUS loan with other federal student loans. As mentioned in the previous section, a Parent PLUS loan can be consolidated to be eligible for the ICR repayment plan. However, preferred repayment plans such as IBR, PAYE, and REPAYE are not allowed for the consolidated loan.
If a loan combines many federal loans into one consolidated loan and includes a Parent PLUS loan, the new combined loan will not be eligible for IBR, PAYE, or REPAYE. This mistake could easily cost the borrower many thousands of dollars. It can be the biggest mistake anyone can make with Parent PLUS loans.
Another mistake borrowers can make when consolidating student loans is to consolidate too late. For example, a borrower could have 100 of the 120 payments required to qualify for public loans. If that borrower were to pool their loans into a new federal direct loan, that new loan would have 0 of the 120 required payments. In this example, the borrower could lose more than eight years of eligible payments for forgiveness.
Borrowers who may have made some progress in public service loans with their existing loans should submit an employer certification form to get an overview of their loan status. A consolidation failure could cause you to start from scratch.
Because of the potentially harmful results of consolidation, borrowers must consider program capability and progress prior to consolidation. In some cases, consolidation will be an essential step; it would be a big mistake with others.
How Do I Consolidate Federal Student Loans?
The actual process of direct federal consolidation is very simple.
The Ministry of Education will process all documents electronically. They estimate it takes about 30 minutes to fill out the form.
One potential problem borrowers should avoid would be third party student loan consolidation services. These “companies”, perhaps more accurately referred to as fraud, promote a special relationship with the Ministry of Education. They claim to help borrowers qualify for income-based repayment plans and student loan origination. In reality, they act as a middleman who gets paid and doesn’t add value to the service. In many cases, they make mistakes and complicate the process even more than necessary.
These companies have gone so bad that at the top of the Department of Education student loan consolidation information page, it says:
As long as borrowers stick to the Department of Education’s official student loan consolidation page and only consolidate when needed, the process is relatively simple.
In addition to deciding which loans to include in the consolidation, borrowers must also consider their options for the repayment plan. One of the options allows borrowers to choose the plan with the lowest monthly payments. However, because multiple plans may have the same low monthly payment, borrowers should look for their preferred repayment plan before consolidating. There are several repayment options that borrowers should consider.
Student Loan Consolidation vs. Refinancing
Student loan consolidation and refinancing are terms that are often used interchangeably. Many lenders who refinance student loans refer to their service as Consolidation.
The best way for borrowers to keep track of things is to look at it this way:
Student Loans Consolidation is only run by the federal government and converts various federal loans into a federal direct loan. Student loan consolidation does not lower or raise interest rates. (The Department of Education takes the weighted average of the loans and rounds it to the nearest eighth percent.)
Refinancing student loans is a process provided by private lenders. You pay off old loans and in return the borrower agrees to repay the new loan on the terms of the new lender. Usually this is done to get a lower interest rate. Both federal and private loans can be refinanced. Many different companies offer refinancing services. Hence, borrowers need to examine their options and understand the ramifications of refinancing private student loans.
Important Details to know before you start Federal Direct Consolidation
Consolidation can result in two loans instead of one – Federal consolidation is typically portrayed as a way for borrowers to consolidate all of their federal student loans into a single loan. Many borrowers get two separate loans when they consolidate. This is because the Department of Education keeps the subsidized loans separate from the unsubsidized loans.
Consolidation is one of the rare ways to switch federal service providers – During the student loan consolidation process, borrowers have the option to choose their preferred loan service provider.
The impact on creditworthiness is minimal – When consolidating borrowers, creditworthiness can easily change. For some borrowers, it rises because the old loans are shown as fully paid and it is usually better to have one large debt than many small debts. Others see their scores drop because their student loans were the oldest point in their credit score and average credit age is a factor. In general, consolidation doesn’t move the credit needle very much. The money saved is a much bigger factor.
Hold back consolidation when looking to buy a home – A number of important changes to a credit report can be a concern for mortgage lenders. Borrowers who are about to purchase a home should discuss consolidation with their mortgage company before beginning the process.
The consolidation process can take months – Filling out the form can only take 30 minutes, but the actual process can take months. In order to consolidate, all old loans must be repaid in full, and this math will take some time to support the Department of Education. After the calculation is complete, the borrower should receive a letter giving them one last chance to unsubscribe from the consolidation. Although no action by the borrower is required during this time, the consolidation process is somewhat time consuming.
Consolidation can be used as a way out of the standard – Borrowers who have fallen far behind on their student loans can use consolidation as a quick fix to get out of default. However, borrowers also have the option to rehabilitate their loans before consolidation. There are several factors that borrowers should consider when deciding between renovating and consolidating their defaulted loans.
Private loans cannot be included in a federal consolidation – It would be great to be able to convert a private student loan into a federal government loan, but it’s not an option.
There is no minimum credit rating or income requirement – In contrast to refinancing with a private company, all federal borrowers are allowed to consolidate their federal loans. There is no credit check.