Should I consolidate or refinance my student loans?

If you have federal student loans, you have the option to combine some or all of your federal student loans into a Federal Direct Consolidation Loan (Direct Consolidation Loan). If you consolidate non-direct loans into a Direct Loan, you gain certain federal protections and benefits such as Public Service Loan Forgiveness (PSLF), which can eliminate your balance after 120 qualifying payments (10 years).

A Direct Consolidation Loan has a fixed interest rate that’s the weighted average of the interest rates of the loans being consolidated, rounded up to the nearest one-eighth of a percent. While consolidating your loans may slightly increase your interest rate, it will lock you into a fixed rate, so your new payment won’t change over time, if they’re based on a standard repayment plan. Note that original Direct Loans, if issued after mid-2006, also have a fixed interest rate, but loans issued before that may not.

If you have private student loans, you don’t have the same protections or benefits as federally funded loans, but you can consolidate multiple loans into one private loan or refinance your loans to get a better interest rate.

Consolidation allows you to combine all or some of your private and federal student loans into one large private consolidation loan through a private lender or bank. Refinancing your existing private student loans would allow you to get into a new private loan at a lower interest rate, especially during periods of low interest rates.

Keep in mind that private student loans can be either fixed or variable interest rates, and the rates you’re offered are based on your credit history. If you take out a private student loan as a student, you may have a limited credit profile, and as a result, the interest rates tend to be higher. However, once you’ve graduated and get a job, you can built up your credit, which may allow you to get a new loan at a lower interest rate.

Refinancing or consolidating your existing private student loans into a new private loan, might allow you to:

• Lower your interest rate
• Lower your monthly payment by extending the length of the repayment term, which may increase the total loan cost
• Release a co-signer from your existing student loan—depending on the terms of the consolidation loan.

It is important, though, to evaluate the terms of a potential private refinance loan carefully before making your decision. Here are some things to consider:

• Look closely at the APR. The monthly payment on your new loan might be lower, but the interest rate could be higher. This can occur because the loan term might be spread out over more years. Active-duty servicemembers should remember that they might also lose the 6-percent interest rate cap benefit under the Servicemembers Civil Relief Act (SCRA) if they refinance.
• Consider the tax consequences. If you consolidate or refinance student loans with non-student loans into one loan, the refinanced loan may no longer qualify for the student loan interest tax deduction. If you regularly claim this deduction, be sure to consider whether the new loan will allow you to continue to do so.

If you’re considering consolidating federal student loans into a private consolidation loan, keep in mind that you will lose the federal loan’s benefits and protections. Weigh the benefits and risks since this type of consolidation can’t be reversed.

• Be aware of the risks of variable interest rates. Most federal loans have fixed interest rates, meaning you never have to worry about your interest rate and monthly payment increasing if interest rates rise in the future. If you switch from a federal to a private loan with a variable rate, however, your interest rate could rise above the original fixed rate and your payment could go up.
• Understand the impact of changing the repayment term. The lowest rates offered by private student loan refinancing programs are likely accompanied by shorter repayment periods. With a shorter repayment period, you generally have a higher monthly payment. With a longer repayment period, your payments are smaller, but you’ll pay more interest over the life of your loan.
• You will no longer qualify for certain repayment programs or plans. Federal student loans provide options for borrowers who run into trouble, including income-driven repayment (IDR). If you consolidate with a private lender, you will lose your rights under the federal student loan program, including deferment, forbearance, cancellation, and affordable repayment options , although you may still qualify for relief options like forbearance under a private loan.
• You will probably lose certain loan forgiveness benefits if you refinance. Borrowers working in public service or as teachers in certain low-income schools may be able to get loan forgiveness for certain federal loans. If you refinance your federal loan with a new private student loan, you will no longer be eligible to participate in these federal loan forgiveness programs. You may also lose the protection of loan discharge or forgiveness in the case of death or permanent disability, which you get with federal student loans. Many but not all private lenders currently offer loan discharge benefits or forgiveness in the case of death or permanent disability.
• Active duty servicemembers may also lose benefits on pre-service obligations if they refinance. If you are a servicemember on active duty, you are eligible for an interest-rate reduction under the Servicemembers Civil Relief Act (SCRA) for all federal and private student loans taken out prior to the start of your service. If you consolidate your loans while serving in the military, you will lose the ability to qualify for this benefit.

If you have equity in your home, you may find that paying back outstanding student debt with a new home equity loan or HELOC looks appealing, but putting more debt on your home can lead to problems down the road.

Before you take out a home equity loan to pay off a student loan, look first for a student loan refinance product and see what rate you can get. You may be able to lower your interest rate without some of the risks that come with tapping the equity in your home. Here are a few things to consider:

• Your rate may be lower, but your home is at risk. Interest rates for home equity loans are generally lower than interest rates for student loans. Lenders are willing to offer a lower interest rate because they know that if you don’t pay, they have a legal claim on your home. If you can’t pay, you could end up in foreclosure.
• If you have federal loans, you are giving up repayment options and forgiveness benefits. Federal student loans feature a number of protections that could lower or forgive your debt in the future, including Income-Driven Repayment. These benefits no longer exist when you pay off a federal student loan with a home equity loan.
• It may impact your taxes. You may wish to consult with a tax advisor when considering your options.

For student borrowers with plenty of savings for a rainy day, a steady income, and a solid understanding of the tax benefits, a home equity loan may offer an opportunity to pay off your student loans at a lower interest rate. But there is always a risk of losing your home if you don’t make your payments.