Debt Consolidation vs. Refinancing

Private, Federal, and Other Types of Loans

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If your loans need a tune-up, there are several ways to simplify life and reduce your expenses. Two of the most common options include debt consolidation and refinancing. You might need to do one or both of those, so get familiar with what they do (and don’t do) for you.

Consolidation vs. Refinancing

First, it’s helpful to clarify the differences between student consolidation and refinancing a loan.

Consolidation happens when you combine multiple loans into a single loan. The concept is many to one: instead of dealing with several separate loans, monthly payments, and billing statements, you can bundle everything together and handle it with one payment. If you prefer, you could call this “simplification” instead of consolidation.

Refinancing is when you replace a loan (or multiple loans) with a completely new loan, ideally a much better loan. The goal is often to get a lower interest rate so that you can reduce your lifetime interest costs and your monthly payment. When you refinance, you can also consolidate at the same time (by paying off multiple loans with your new loan). Instead of the term refinancing, you might think of this as “optimizing” your debt so that you pay less.

True consolidation only makes sense (and it's only possible) if your student loans originally came from government programs. You can “consolidate” private loans by bundling multiple loans together, but the major benefits of consolidation are reserved for government loans.

Debt consolidation "programs" can also cause confusion: programs are services offered by credit counseling agencies and similar organizations. The idea is that the agency will negotiate with creditors to make payments more affordable. You do only make one payment, but the payment goes to the agency, which then pays off your multiple loans for you.

Federal Loan Consolidation

When you have multiple federal student loans, you can consolidate those loans using a Direct Consolidation Loan. The interest rate you pay, as a whole, will not change – you’ll end up with a weighted rate on the resulting loan that is effectively the same rate you were paying on those loans separately. That single rate will apply to all of the debt you consolidate, which may or may not matter (if you somehow had one loan with a high rate relative to other loans, it might be better to pay that off aggressively instead of adding it to your consolidation loan).

Interest rates are fixed on these loans.

Consolidating might also give you the option to change your repayment schedule. For example, you might be able to stretch out repayment over 25 years instead of a shorter period. However, a longer repayment period means you’ll pay more interest over the life of those loans, you’ll enjoy a lower monthly payment today at the expense of a higher overall cost.

What about combining federal student loans with private loans? You can do that if you use a private lender (not through a federal Direct Consolidation Loan), but you’ll want to evaluate that decision carefully: once you move a government loan to a private lender, you lose the benefits of federal student loans. For some, those benefits aren’t helpful, but you never know what the future brings, and features like deferment and income-based repayment might come in handy someday.

Refinancing with Private Lenders

A private loan consolidation is only an option if you refinance your debt. In the private market, lenders might be willing to compete for your loans, and you can get a good deal if you have good credit. Since credit scores change over time, you might be able to do better now if you’ve been making payments on time for several years.

Refinancing can help you simplify, but it’s really about saving money. If you can get a lower interest rate (or some other advantage), you’ll be in a better position. Again, it’s possible to stretch out your repayment over future years — every time you refinance, you start the repayment process over — but that can cost you over the long term. To see how this works, get familiar with loan amortization (which is the process of paying down loans).

When you refinance, you’ll either end up with a fixed or variable rate loan. Make sure to understand how the rate works, and what will happen if interest rates change — will your monthly payments go up someday?

Other Types of Debt

While you’re refinancing, you might be tempted to include other types of debt into your new loan (auto, credit card, or personal loans, for example). Although it would simplify things, this generally cannot be done with a student loan. However, there are other types of loans that can handle different types of debt.

Personal loans can be used for anything you want. That means you could use a personal loan to refinance your student debt, a credit card or two, and your auto loan. Of course, this only makes sense if you’re truly going to save money (and avoid racking up debt again once you free up those lines of credit).

Should you Consolidate or Refinance?

If you have federal student loans: Evaluate the pros and cons carefully — especially if you’re tempted to switch to a private student loan. Using a federal consolidation loan isn't terribly risky. But moving from federal loans to private loans is not something you can reverse — you’ll lose the benefits of those federal loans forever. For example, if you work in public service, you might have the opportunity to get federal loans forgiven after 10 years of employment — good luck getting that deal from a private lender.

Federal loans might also allow you to change (lower) your monthly payment based on your income, but private lenders are less accommodating.

Consolidating your federal loans separately (using a federal consolidation loan and handling private loans separately) gives you the simplicity of one monthly payment, and you’ll get a fixed rate so that you always know what your payment will be.

If you have private student loans: It’s always worth shopping around to see if you can get a better deal. Look for a lower interest rate, low (or no) application and processing fees, and other terms that mean you’ll truly save money. Make a quick amortization table for each loan including your existing loan, and go with the option that works best for you.