TUN sits down with Betsy Mayotte, the president and founder of The Institute of Student Loan Advisors (TISLA), to discuss what you should know before you consolidate your student loans.
TUN: Betsy thanks so much for joining us.
What does it mean to consolidate your student loans?
As opposed to refinancing, when we talk about consolidating student loans, we’re almost always talking about federal student loans. What consolidation means is, you take your individual loans, which get paid in full, and you create one new loan that is all those loans combined.
There’s only one place to do that. It’s through the Department of Education, which is studentaid.gov. It’s free to do that. I emphasize that because there are some dirty companies out there that offer to do it for you for a fee. The process is super easy and, again, it’s free. So, there are zero reasons to pay anyone to do this for you.
The interest rate for a consolidated federal student loan is a weighted average of the interest rates of the underlying loans. They round up to the nearest eighth of a point. So, you can’t refinance federal student loans in the sense of getting a lower interest rate. But, what it does do is, it extends the term, which can lower your payment. So, whereas regular student loans have a 10-year repayment term, a federal consolidation will have a term of 12-30 years.
Great. When should borrowers consider consolidating their student loans?
That’s a great question because there’s still sort of this myth out there that everybody should consolidate.
That tracks back to the early 2000s, when everybody should have consolidated. The reason for that is, back then, most federal student loans had variable interest rates, so the rate would change every year depending on what was going on in the economy. Most of them only went up to like 8 percent, but some could go as high as 12 percent or 14 percent. So, in the early 2000s, the rates got super low, like 1 and 2 percent. Consolidation was a way to lock in that low rate. So, when you consolidated, they used whatever your rate was at the time. So, if your rates were 1 or 2 percent and you consolidated, that is what your consolidation interest rate was and it was locked in at that rate.
So, back then, everyone consolidated, and they should have! The other reason people consolidated back then is, it wasn’t uncommon to have four loans and four different servicers, which is confusing. So, consolidation was also a way to get a single bill.
Today, interest rates are fixed. Any loan made after 2006 has a fixed interest rate. So, consolidation isn’t going to help you there. And, the Department of Education has done a pretty good job making sure the whole four loans and four different servicers thing doesn’t happen anymore. So, you’re going to end up with a single bill anyway.
Reason to consolidate today
The only reason to consolidate today is to get access to a program that you might not be eligible for already. For example, if you have older loans from what used to be called the Federal Family Education Loan program (FFEL), those loans aren’t eligible for things like Public Service Loan Forgiveness or most of the income-driven repayment plans. However, if you consolidate them into the Direct Loan program at studentaid.gov, they become eligible for that.
So, someone with those old FFEL loans, or even a Perkins loan, might want to consolidate if they want access to those programs.
The other people who should consider consolidation are those with Parent PLUS loans. Now, I know a lot of families have an arrangement where the parent takes out the Parent PLUS loan but the student agrees to make the payments. Most of the lower payment options are going to be based on the parent borrower situation, so a Parent PLUS loan is not eligible for any of the income-driven plans. However, there’s a loophole where if you consolidate the Parent PLUS loan, you get access to an income-driven plan called Income Contingent. So, that’s something for a family to look into, if there are Parent PLUS loans in the family and they’re looking to get a lower payment.
Other than that, there’s really no value for most people to consolidate these days.
For borrowers who do decide to consolidate their loans, what are the next steps? Can you provide some tips to make the process smooth and easy?
The process is pretty easy. You go to studentaid.gov, and you apply online.
One thing I would point out is, within the promissory note that you’re filling out, there is one page for you to write loans that you want consolidated and one page for you to list loans you don’t want to be consolidated. If there are loans you don’t want to be consolidated, make extra sure to fill out that second page. Don’t just leave them off that first page that I mentioned.
Consolidation also gives you the ability to choose your loan servicer out of all the ones that work for the Department of Education.
The only other thing to prep for is, you could also choose your repayment plan at that point. You don’t have to, and if you don’t, they’ll just put you on a standard plan where your payments are the same for however many years the consolidation is. But, if you’re going to need a lower payment plan, do your research ahead of time so while you’re filling out the application you can make that choice too.
Great. So, if you have both private and federal student loans, can you consolidate them together?
Yes. But now ask me if it’s a good idea.
Is it a good idea?
You can’t consolidate private loans into the federal loan program. The only way to do it is to refinance your federal loans into the private loan program.
And, as I have mentioned at other times that we’ve talked, that’s almost always a terrible idea. If you do that, you lose all the protections that are unique to federal student loans that aren’t available for private loans, such as the lower payment options and forgiveness programs. Or if something really bad happens – if you become disabled, God forbid, you pass away – federal loans have discharges . Generally, those discharges aren’t available on private loans as they are on federal.
And there are no take-backsies. Once you do it, you can’t reverse it.
Great. Are there any potential repercussions to consolidating student loans? Could the decision come back to bite students in any way?
Yeah. There are a couple.
If you’re pursuing an income-driven plan — even those old FFEL loans are eligible for an income-driven plan — all of your past history on the original income-driven plan gets wiped away when you consolidate.
Let’s say you were 10 years into an income-driven plan and after 20 or 25 years, the balance is forgiven. If you consolidate, that 10-year history goes away and you’re going to have to pay for the full 20 or 25 years.
I see this all the time for Public Service Loan Forgiveness and it breaks my heart because, again, you can’t reverse it. If you’re pursuing Public Service Loan Forgiveness and you already have some eligible payments under your belt, if you consolidate, it wipes all those payments away and you cannot reverse it.
The last potential repercussion is a little more subtle. Overall, whether you consolidate or refinance or not, the name of the game when it comes to student loans is paying the least amount over time. Unless you’re pursuing a loan forgiveness program in some way, the way to pay the least amount over time is to pay the loan off as quickly as you can.
Interest accrues on a daily basis on whatever the outstanding balance is. Some people don’t realize this until late. They wake up one day and go, “Wait a minute. I’ve been paying my student loans for 15 years. I’ve got to be almost done.” And they look and go, “Oh my goodness. I still have 15 years left. Why is that?” It’s because you extended the term of the loan.
You can always pay extra. There’s never a prepayment penalty. I always advise people, regardless of what they’re doing with their student loans, to reevaluate their student loan strategy every year. Tax time is a great time to do it. So, that will help prevent the interest creep that can happen if you consolidate and take the full 30 years to repay the loan.
Great. Do you have any additional tips or pieces of information that you would like to add that I may have skipped over?
Federal loan consolidation is pretty straightforward. The last thing that I would mention is, the way they book the loans can look a little confusing.
So, for federal loans, there are subsidized loans, which don’t accrue interest while you’re in school, have a grace period or deferment in most cases, and also have subsidies available under the income-driven plans. Then there are unsubsidized loans, which accrue interest from day one and accrue interest every single day until the loans are paid off.
The nice thing about consolidation, which actually wasn’t always the case, is that when you consolidate, you maintain those subsidies.
Let’s say that half of your loans were subsidized and half were unsubsidized. If you go into deferment or something that’s a subsidy-eligible event, they’re going to maintain the subsidy for that portion of the consolidated loan.
Well, the only way they can do that accurately is by, on the books, separating the loan into two pieces. So, borrowers think they have two loans. Legally, they don’t. If you look at your credit report, it’s going to be one loan. If anything ever came up legally, it would be one loan. But, if you look at the servicer’s website, your bill or even your repayment history, it’s going to look like two loans. So, it’s good for people to understand that it isn’t really two loans.
Great. Thanks, Betsy, for joining us today.
Yeah. Thanks for having me.
This interview has been edited for clarity.