This page discusses the pros and cons of consolidation. Although the
switch to fixed interest rates on Stafford and PLUS loans eliminated
one of the financial incentives to consolidate, there are still
several reasons why borrowers may want to consolidate their education
Reasons to Consolidate
The key benefits of a consolidation loan include the following:
- Single monthly payment.
Consolidation replaces the multiple payments on multiple loans with a
single payment on the consolidation loan. A student might graduate
with as many as a dozen loans or more. Consolidation combines these
into a single loan with a single monthly payment. This simplifies the
- Alternate repayment plans. (More manageable monthly payments.)
Consolidation provides access to alternate repayment plans, such as
extended repayment, graduated repayment, and income contingent
repayment. Although these plans may be available to unconsolidated
loans, the term of an extended repayment plan depends on the balance
of the loan, which is higher on a consolidation loan.
Alternate repayment plans often reduce the size of the monthly payment
by as much as 50% by increasing the term of the loan. This can make
the monthly payments more affordable and management, but it does
increase the total interest paid over the lifetime of the loan.
- Reduces the interest rate on some PLUS loans.
Consolidating an 8.5% fixed rate PLUS loan reduces the interest rate
by 0.25% because of the lower 8.25%
interest rate cap on consolidation loans. To maximize the interest
rate reduction, the PLUS loans must be consolidated by
themselves. However, one must also consider the impact of
consolidation on available student loan discounts.
- Resets the clock on deferments and forbearances.
Consolidation resets the 3-year clock on certain deferments and
forbearances. A consolidation loan is a new loan, with its own fresh
set of deferments and forbearances.
This is a useful tool for medical
school students, who do not get an in-school deferment during the
internship and residency periods. They are, however, eligible for an
economic hardship deferment for up to three years. If they need more
than three years, consolidation is a useful tool for getting up to another
three years of deferment.
- Restarts the loan term on loans already in repayment.
Even if you stick with standard ten-year repayment, when you
consolidate loans that are already in repayment, it resets the loan
term on those loans, since a consolidation loan is a new loan. This
can give you some of the benefits of an alternate repayment plan, such
as a lower monthly payment, without extending the term as much as
typically occurs with extended repayment.
On the other hand, if you are close to the end of your repayment term,
you might want to avoid consolidation because the savings will not be
great enough for it to be worth the bother.
- Switch lenders for better loan discounts.
Consolidating your loans allows you to switch from one lender to
another. You can also switch from Direct Loans to FFEL and vice
versa. If you shop around, you might be able to get a better discount
on loan interest rates and better rebates on the fees.
With the switch to fixed rates on Stafford and PLUS loans first
disbursed on or after July 1, 2006, the ability to lock in the
interest rate on a variable rate loan is no longer relevant for most
Students could also previously consolidate during the in-school or
grace period to lock in the lower in-school interest rate using
in-school interest rate loophole, which
was repealed in 2006.
Nevertheless, borrowers who still have unconsolidated variable rate
loans may wish to consider consolidating during the grace period to
lock in the lower in-school rate. (The interest rates on variable rate
loans also change each July 1, based on the last 91-day T-bill auction
in May. Depending on whether the rates are increasing or decreasing,
borrowers might want to consolidate before or after July 1. Many
lenders will hold the consolidation loan application to provide
borrowers with the best rate and to maximize the grace period. But
when interest rates are less volatile, consolidating during the grace
period is often more important than the July 1 change in rates.)
Some graduate students have found it necessary to consolidate their
educational loans when applying for a mortgage on a house.
There are, however, a few problems with consolidation that you should
be aware of when considering a consolidation loan:
- Loss of the Grace Period.
When a borrower consolidates during the grace period, the borrower
has to begin repayment immediately and loses the remainder of the
grace period, including possibly interest benefits on subsidized loans.
However, several lenders will delay the payoff of your original loans
for as long as possible, to allow you to derive maximum benefit from
the grace period on those loans. This involves exploiting the
grace period loophole.
Alternately, if you cannot begin repaying the consolidation loan
because you are still looking for a job, you can apply for an
unemployment deferment or an economic hardship deferment. These
deferments allow you to delay repaying the loans for up to three
years. Interest continues to accrue on unsubsidized loans, and must
either be paid or added to principal through capitalization. (Note
that you must continue making payments on the consolidation loan until
your application for a deferment is approved. If you fail to make
payments, your loan will go into default, and this will prevent you
from obtaining a deferment.)
- Loss of subsidized interest benefits on Perkins Loans.
The interest benefits on a Subsidized Stafford Loan survive
consolidation. This means that the federal government continues to pay
the interest on the portion of the consolidation loan that resulted
from the payoff of a subsidized Stafford loan while the borrower is in
school or during other deferment periods. The interest benefits on a
Perkins Loan, however, do not survive consolidation.
- Loss of other benefits of the Perkins Loans.
In addition to losing the Perkins loan's 9-month grace period and
subsidized interest, borrowers who consolidate Perkins Loans also lose
the Perkins Loan's favorable loan forgiveness provisions.
- Extended Repayment is Optional, Not Mandatory.
Extending the repayment term may increase the total interest paid
over the lifetime of the loan.
Some lenders have been encouraging (or at least, not discouraging)
borrowers to obtain extended repayment on their consolidation
loans. They do this in subtle ways, such as using a 20 year term
instead of a 10 year term in their repayment examples.
Borrowers are not required to pick an alternate repayment term, like
extended repayment. Borrowers can stay with standard ten-year
repayment even if they consolidate. We recommend keeping a standard
repayment term, as this minimizes the total cost of the loan.
You should only choose an extended or alternate repayment term when
you are experiencing trouble making your monthly payments. The
alternate repayment terms can reduce the size of the monthly payments
by as much as 50%, but at a cost of increasing the total interest paid
over the lifetime of the loan by as much as 250% or more. The
alternate repayment plans can increase the cost of the loan by
thousands or even tens of thousands of dollars.
Lenders have a financial interest in encouraging borrowers to use
alternate repayment. Lender profits are increased when borrowers have
higher loan balances for longer terms. A 20 year term, for example,
increases the average annual loan balance by about 10% as compared
with a 10 year term, and doubles the repayment term. So the total
interest paid is about 2.2 times higher on a 20 year term as compared
with a 10 year term. Lender margins are tighter on consolidation
loans, due to fees paid to the US Department of Education, so their
annual profit on a consolidation loan is lower. However, if they can
convince the borrower to use extended repayment, the total profits
over the lifetime of the loan are higher.
Some of the arguments lenders give in favor of extended repayment are
reasonable. For example, if you have several forms of debt, you should
use extra funds to pay off the more expensive (higher interest rate)
debt first. This can save you money. You could extend the repayment
term on your low cost federal student loans to reduce the size of the
monthly payment, and use the savings to pay off your private student
loans and credit card debt sooner. This can be part of a good debt
management strategy that minimizes the total cost of all your
debt. But it requires discipline, and extending the term on your
education loans will increase their cost, especially if you fail to
pay off your higher interest debt. So don't do this if you're just
going to spend the savings.
Another argument involves comparing the costs of interest on your
student loans with stock market returns. If you have some extra money
available, should you prepay part of your student loans, or invest the
money in the stock market? Although the stock market has the potential
for greater returns, it is also much riskier. Unless you have a lot of
experience with investing, you are probably better off trying to pay
off your debt as quickly as possible.
After all, do you really want to still be paying off your own student
loans when your children are ready to enroll in college?
- You can only consolidate once.
Current law allows borrowers to consolidate their loans only once. If
you want to include a previous consolidation loan in a new
consolidation loan, you must be adding other loans to the
consolidation loan. Thus, your ability to use consolidation to switch
from one lender to another will be severely limited after you
consolidate, unless you held one or more loans out of the
Note that even if you are able to consolidate a previous consolidation
loan, reconsolidation does not relock the interest rates on
the existing consolidation loans. Once the interest
rate on a consolidation loan is fixed, it does not change.
- Inferior loan discounts.
Lenders who offer borrower benefits for electronic funds
transfer and making payments on time tend to offer less favorable
benefits for consolidation loans. Most lenders offer a 0.25% interest
rate reduction when you sign up to have your monthly payments direct
debited from your bank account. However, the typical discount for
making all of your payments on time is a 1% interest rate reduction
after 36 months of on-time payments, instead of 2%. This is partly
because the profit margins on consolidation loans are tighter than on
unconsolidated loans. However, we expect to see increased competition
on price among consolidators, now that the single holder rule has been
repealed, so consolidators may soon start offering better discounts to
encourage borrowers to switch lenders. Originating lenders and
secondary markets may respond by improving the benefits for loans that
- Capitalization at Status Changes. Accrued interest on an
unsubsidized Stafford Loan must be capitalized when the loan is consolidated.
- You don't need to consolidate to get extended repayment.
A little known provision of the Higher Education Act of 1965, in
section 428(b)(9)(A)(iv), allows borrowers to get extended or graduated
repayment without consolidating their loans. The borrower must have
accumulated more than $30,000 in federal education debt since 1998.
The extended or graduated repayment plan may have a loan term of up to
Per the regulations at 34 CFR 682.209(a)(6)(ix), the borrower must not
have had any outstanding federal education debt prior to October 7,
1998 at the time of obtaining a new education loan subsequent to that date.
Many lenders also offer unified billing, so that you get one bill
for all your loans from that lender.
Before July 1, 2006, married couples could jointly consolidate their
loans. Although this
could qualify the couple for a longer repayment term and lower monthly
payments, it often caused problems when a couple got divorced
later. By jointly consolidating the student loans, each spouse assumes
full responsibility for repaying the debt. It is not possible to split
up the debt during a divorce proceedings, so each spouse remains
responsible for paying back the loans. If one ex-spouse fails to make
a monthly payment, the other ex-spouse is responsible, and his/her
credit record is affected. Similarly, the loan is no longer eligible
for an in-school deferment, since both spouses must be enrolled in
college for the loan to qualify for a deferment. (If one spouse
dies or becomes permanently disabled, however, that portion of the
debt is forgiven.) For these reasons, Congress repealed the ability
for married borrowers to consolidate their loans together as part of
the Higher Education Reconciliation Act of 2005.
Consolidating a fixed rate loan, such as a Perkins Loan, will not save
you any money on the fixed rate loan. Consolidating does not reduce
the underlying rate of a
fixed rate loan, although it can increase it slightly, due to the
rounding up to the nearest 1/8th of a point. (On the other hand, if
the weighted average of the interest rates on the other loans would
have resulted in the interest rate being rounded up nearly 1/8th of a
point, including a fixed rate loan might mask some of the roundup,
indirectly saving a little money. Likewise, if the weighted average
was just below the 1/8th of a point boundary, including a fixed
rate loan that bumps it over the 1/8th of a point boundary could
increase the interest rate by up to 1/8th of a point beyond what it
would have been otherwise. Thus including a Perkins Loan in a
consolidation loan can cause the interest rate to be up to 1/8th of a
percent higher or lower than it would otherwise have been, depending
on whether it moves the weighted average of the interest rates closer
to or beyond the next 1/8th of a percent boundary.) However, many
banks provide a 0.25% reduction in the interest rate for signing up
for automatic bank debit, which may make consolidating a Perkins loan
financially worthwhile. (Note that there is a financial benefit to
consolidating an 8.5% fixed rate PLUS loan, due to the lower 8.25%
interest rate cap on consolidation loans.)