How to tell if consolidating your student loans can save you money

The Federal Reserve cut interest rates three times over the past few months, making many loans a lot cheaper for Americans. For some, that may mean it’s a good time to consolidate their student loans and lock in lower interest rates.

While many student borrowers have federal student loans with a fixed interest rate, about 1.4 million Americans borrowed from private lenders, according to a report by LendEdu. Private student loan interest rates, which can be fixed or variable, aren’t directly tied to the federal funds rate. Yet they are based on Libor (London Interbank Offered Rate), which tends to move in tandem with any Fed adjustment.

That means if you have a private student loan with a variable interest rate, you may see a slight dip. If you have a fixed rate private student loan, the cuts won’t affect you directly. However, it still could be a good time to consider consolidating your loans and refinancing at a lower interest rate.

“Consolidating can be a great tool for your student loans,” says Tiffany Aliche, personal finance expert and founder of The Budgetnista. But it pays to understand how the process works and which types of student loans benefit the most from refinancing.

Here’s a look at what you need to consider.

There are fundamental differences between public and private student loan options.

Private student loans are pretty straightforward. “The thing that people don’t realize is that a private student loan is really just a loan. It could be a car note, it could be a mortgage. It’s just a loan that you happened to use for education,” Aliche says. Interest rates on these loans range from 3.8% to nearly 13% among the biggest lenders, according to research site ValuePenguin.

But federal student loans are different. They have built-in benefits, as well as fixed, low interest rates. For the 2019-2020 school year, federal student loan interest rates are currently 4.53% for undergraduate loans.

One of the biggest benefits for those in the process of paying back their federal student loans is that you can get a break if you experience financial hardship. If you can’t pay back your loan because you lose your job, you can claim financial hardship and temporarily elect to receive a deferment or forbearance on your payments. This will allow you to stop or reduce your payments for the short-term until you get back on your feet financially.

If you stay within the federal student loan system, consolidating doesn’t save you money, it simply combines multiple loans into one. It may lower your monthly payment by extending the loan period, but if you do take that route, your interest will increase.

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Some borrowers opt to consolidate their federal student loans into a private loan, but that can be a mistake, Aliche says. You may be getting a lower interest rate, but if you lose federal loan benefits that you’re currently utilizing, consolidating could end up costing you money.

One reason is because there are several repayment options with federal student loans that offer income-based repayment plans to make payments are more manageable. If you consolidate your federal student loans into a private loan, your monthly payment may no longer be tied to your monthly pay. That means should you get a lower-paying job, you may find your loan repayment obligation is now too high and depending on your agreement, you may not have a lot of wiggle room.

“I don’t want you to make the mistake and consolidate yourself out of federal student loans, because if you do that, you are going to lose some of the protections allotted to you,” Aliche says.

Before you even start to think about consolidating, make sure you have a good track record of on-time payments, a stable job and a credit score that’s in the good to excellent range. Typically, you need to have a credit score over 690 to refinance your student loans. If you’re missing any of these components, you may need to get a co-signer, such as a parent.

When you’re looking to consolidate, Aliche recommends focusing on finding a solution where you have fewer payments than you had before. Do your homework and explore the refinancing options with multiple lenders. It’s also worth exploring the lender’s track record with customer service. There are several online tools that can help you compare lenders’ reviews and rates side-by-side and the Consumer Financial Protection Bureau has a consumer complaint database that includes student loan lenders.

Additionally, make sure you read the fine print and that you understand all of the loan terms. “Ask the questions,” Aliche says. Some lenders provide flexible options for repayment, including options to make interest-only payments and an interest rate reduction after a certain percentage of the principal has been paid off. But if you default, you may be on the hook for expensive fees from collection agencies.

Ideally, you want to consolidate at a lower interest rate than the other payments had on average. “Let’s say you average out the interest rates from the payments before and it’s 7% and you’re able to consolidate to this one payment and it’s 5% — you, my friend, are winning,” Aliche says. But be careful that you keep the monthly payments reasonable for your budget.

Currently, some of the bigger private refinancing companies such as SoFi and Earnest are offering rates as low as 3.5% for a fixed rate loan. To help, Nerdwallet has a student loan consolidation calculator that can help you determine if the new loan saves you money.

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