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Be careful if you want to combine private and federal loans with private student loan consolidation

Should You Combine Student Loans? » Student Loan Debt » Should You Combine Student Loans?



When it comes to student loans, it seems like nothing is ever easy. In some cases, it almost appears they went out of their way to make the process as confusing as possible. So, it should come as no surprise that there are hidden risks involved in consolidating your student loans. Here’s what you need to know before you combine student loans into a single consolidated payment.

How to combine student loans into a single repayment plan

There is only one debt relief option that allows you to combine both federal and private student loans together. It’s called private student loan consolidation.

  1. You apply for a consolidation loan through a private lender, such as your bank or an online lending company.
  2. The amount you wish to finance is equal to the total balance of loans you wish to pay off; since the goal here is to get one single monthly payment, this should be your total student loan debt.
  3. You set the term based on the monthly payments you can comfortably afford to make with your income.
    1. A longer term (more months) means lower payments, but higher total cost
    2. A shorter term reduces total cost, but also increases the required monthly payment
  4. During underwriting the lender will likely consult with you to get a list of each loan you hold and the current balance to pay off.
  5. The lender approves the loan and sets the rate based on your credit score; if you have a cosigner then the lender considers the credit of both you and your cosigner.
  6. Once approved, the lender typically disburses the money directly to the loan servicers you listed during underwriting.
  7. This pays off all your other student loans, leaving only the new loan to repay.

There’s good reason to combine student loans this way

This kind of full consolidation allows you to simplify student loan repayment as much as possible.

  • You only have one monthly payment to worry about
  • The amount you pay is fixed, so there’s no uncertainty about what you may pay next year
  • There’s no need to certify your income or recertify every year to keep the loan going

None of the above are guaranteed if you use federal repayment plans. If fact, if you keep your federal and private loans separate, the best you can hope for is two payments.

In addition, if you use a hardship-based program like an IBR, you must certify your income to enroll. Each year, you must recertify your income and family size to stay enrolled. What’s more, if your income changes then your monthly payment requirement may change, too.

Lower rates are another reason to go private

Another strong reason to convert federal student loan debt into a private loan is to achieve a lower interest rate. If you use a federal repayment plan, credit score doesn’t factor into the rate you pay. Instead, the servicer sets the rate by taking a weighted average of your existing rates. So, you don’t get any benefit from rate decreases by consolidating through the federal system.

This means that borrowers with good credit have good reason to convert their federal student loan debt to private. Just be aware of the consequences…

What you lose when you combine federal student loans with private

In a word: eligibility.

The federal government offers a range of consolidation, repayment plan and forgiveness programs. They have the Federal Direct Consolidation loan, as well as affordable repayment plans, like Pay as You Earn. There’s also the prized Public Service Loan Forgiveness program. This forgives the remaining balances of public servants after 120 payments on a hardship program.

All these programs only apply to federal student loan debt. So, if you have federal student loans and private student loans, you must keep them separate to use these options.

When you combine both types of student loans with a private consolidation loan, federal debt converts to private. The money from the private lender goes to your federal loan servicers to pay off those debts. So, federal student loan debt becomes private student loan debt. Now, this debt is no longer eligible for any federal programs.

That may seem fine now, but if your situation changes, you may miss that eligibility.

Any change in your situation could increase your need for federal relief

The private lender will help you make sure you can afford the consolidation loan when you apply. However, your financial situation can change. If you lose your job or have a medical emergency that reduces the hours you can work, your income decreases. Extended income loss  means you may have difficulty making your monthly payments.

If you use a federal repayment plan for your federal student loans and your situation changes, you can switch plans. You can easily switch between programs to get into a repayment schedule that works for your reduced budget. However, if you consolidated privately, you can’t use federal programs. Ever.

In addition, you may have trouble using deferment and forbearance. Some lenders offer these options on student loans, but they’re usually more limited than federal deferment and forbearance. As a result, you may end up with a debt in collections if you can’t recover and catch up with your payments.

Public servants should really proceed with caution

If you work as a firefighter, police officer, nurse or teacher in the public sector, consider combining student loans carefully. PSLF can be extremely beneficial. It can significantly cut the amount of debt you have to repay; in many cases, you pay less that what you borrowed – that’s according to a GAO report from the government.

In one example from that report, a public servant who borrowed $60,000 only repaid $12,256 with PSLF. That’s a hard deal to beat, even if a private loan would give you a better rate. With private debt, you must always at least repay what you borrowed. This federal program means you don’t.

That being said, it’s worth noting that PSLF qualification is not easy; it’s anything but, in fact. You must enroll in a hardship-based repayment plan, which requires you to certify your income annually. Then you also need to certify your employment each year, plus anytime you change jobs. After that, you still must make 120 qualified payments before the servicer forgives the remaining balances.

To make matters worse, this is a federal government entitlement program. In other words, it’s considered a “welfare” program, which Republicans and fiscal conservatives hate. And changes that Obama made to PSLF made more people eligible, however it increased the cost to $12 billion. That’s put it high on the list of programs that may get axed.

How Much Could You Save?

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