Background on the program—why does this program exist?

The consolidation program has been in place since 1986 when congress enacted the Federal Consolidation Loan Program in an effort to reduce default rates. Federal (Stafford) loans are limited to 5 to 10 year terms, so by increasing the term limits to 15 to 30 years the program is able to lower students’ monthly payments. The legislators decided that the loan would change from a variable rate to a fixed rate—essentially allowing students to refinance their loans once. So while the original intent of the program was to target students at risk for default, the recent interest rate decline has helped other students as well.

How does Consolidation Work?

Federal Consolidation allows borrowers to combine one or more federal education loans and lower their monthly payments. The program allows borrowers to lock-in current rates by switching the loan from variable to a fixed rate. The monthly payment is decreased by extending the period of the loan. While many students perceive the decrease in the monthly payment as a “deal”, lower payment are achieved by extending terms. This process does increase interest costs over time. Once the application process is complete, the original loans are paid-in-full, and a new loan for the combined balance is issued with new terms. The interest rate is calculated as the weighted average interest rate of the loans being consolidated, rounded up to the nearest 1/8 of a percent.

Why Should I Consolidate?

There are two primary reasons why consolidation offers a compelling opportunity today. The primary reason is rates are at their lowest point in the program’s history and consolidation allows you to lock-in these rates. Borrowers who lock-in today’s rates won’t be subject to rate increases if they occur.

The second reason consolidation is attractive is because it can lower your monthly payment by extending the term of your loan. This can help create room in your budget to pay down more expensive debt or other personal items, but you should be aware that the payment decreases because you are paying off the loan over a longer period. This will result in higher interest cost over the life of the loan.

Another benefit worth highlighting is consolidation allows you to pay all your federal loans with one payment.

Who consolidates loans?

While the government sets federal guidelines on the program, two types of lenders offer the program:

• William D. Ford Direct Student Loan Program (Direct) – offered by the US Dept of Education
• Federal Family Education Loan Program (FFELP) - offered through private lenders

The two consolidation programs are identical with the exception of a few subtle differences. One key difference is that Direct Consolidation may be done while a student is still in school, while a FFELP must be done after graduation. To take advantage of Direct Consolidation you need to have at least one Direct loan. A list of Direct Lending Schools can be found at: http://www.ed.gov/offices/OSFAP/DirectLoan/schools/schoolin.html

An issue unique to the FFELP Program is the Single Lender Rule. This states that if a borrower has all his or her federal loans from one FFEL lender then this lender has right of first refusal for consolidation. If this is the case you will be instructed to contact your current FFELP lender for consolidation.

Another difference between the programs is borrower benefits. The Direct Program is offered by the government (DOE), and they offer minimal borrower benefits. Some participants in the FFEL Program however have elected to offer borrower benefits as a marketing incentive to consolidate. The benefits typically take the form of an interest rate reduction (after timely payments) or a reduction to the loan’s principal.

The only other differentiator is customer service. We have obtained a great deal of feedback through the site and the FFEL Program has faired better than the Direct Program. The FFELP call center representatives are said to be more knowledgeable and many of them are open seven days a week.

Note on borrower benefits: All FFELP lenders offering interest rate incentives include a disclosure statement that says something like “we reserve the right to modify or discontinue borrower benefit programs at any time”. We contacted several FFELP lenders and were told that loans consolidated prior to the termination or change of these programs will not be affected by such changes.  

When Should I Consolidate?

This can be tricky. The Stafford loan program announces new rates every July 1^st. The current rate is 5.30% for recent Stafford loans in repayment. Upon consolidation, the rate is rounded up to the nearest 1/8%. This allows you to lock-in a 5.375% rate.

By consolidating during your grace period, however, you lock-in a 0.6% reduction, lowering the rate to 4.75%.

Competition among lenders has introduced incentives which can lower your rate to 3.25% or even lower. While this rate yields a compelling discount to your student loans, it’s important to know that you cannot miss or be late on a monthly payment in order to retain the benefit.

This past July was the first rate increase in five years. The optimal timing depends on the Treasury bill rates in May/June. If rates increase, you may lock in a lower rate by consolidating prior to July 1^st. If rates continue to decline however, you may receive a lower rate if you wait until after July 1, but before your grace period ends.

This time-sensitivity is one of the reasons Graduate Leverage established our Personalized Reservation System which allows students to decide on the most opportune time to consolidate based on the information.

Does Consolidation have risks or drawbacks?

The short answer to this is no. There are no fees or prepayment penalties with a consolidation loan. In the case that you didn’t need the lower payment afforded by consolidation, you could just continue making the same monthly payment and payoff your loans over the same timeframe. The real risk in consolidation is that you lock-in too high of a rate. This was the case for many who consolidated in the past four years (before rates reached current lows). Other things to consider are:

• Spousal Consolidation Loans:
  • If you become disabled, die or have to file for personal bankruptcy your spouse will still be responsible for repaying the entire balance of your joint consolidation loan.
• Perkins Loans:
  • Perkins loans deserve special consideration because they have different deferment and grace subsidy treatment and allow for cancellation under certain circumstances. You may be eligible for partial cancellation of a percentage of the original principal balance of your Perkins (NDSL) loans if you complete at least one year of a service in the following fields: Teaching, Law Enforcement, Military, Volunteer Service (Peace Corps/VISTA), Nursing and Medical Technicians and Child and Family Services.