I have a Stafford loan and a Perkins loan, I was wondering the most appropriate approach to connect these in to one payment. Any ideas?


JamesH February 12, 2014 at 10:07 pm

Loan Consolidation

Loan Consolidation, also called a Consolidation Loan, combines several student or parent loans into one bigger loan from a single lender, which is then used to pay off the balances on the other loans. Consolidation loans are available for most federal loans, including FFELP (Stafford, PLUS and SLS), FISL, Perkins, Health Professional Student Loans, NSL, HEAL, Guaranteed Student Loans and Direct loans. Some lenders offer private consolidation loans for private education loans as well.

How It Works

Consolidation loans often reduce the size of the monthly payment by extending the term of the loan beyond the 10-year repayment plan that is standard with federal loans. Depending on the loan amount, the term of the loan can be extended from 12 to 30 years. The reduced monthly payment may make the loan easier to repay for some borrowers. However, by extending the term of a loan the total amount of interest paid is increased.

Loan Balance Extended Repayment Term
Less than $7,500 10 years
$7,500 to $10,000 12 years
$10,000 to $20,000 15 years
$20,000 to $40,000 20 years
$40,000 to $60,000 25 years
$60,000 or more 30 years

In certain circumstances (for example, when one or more of the loans was being repaid in less than 10 years because of minimum payment requirements), a consolidation loan may decrease the monthly payment without extending the overall loan term beyond 10 years. In effect, the shorter-term loan is being extended to 10 years. The total amount of interest paid will increase unless you continue to make the same monthly payment as before, in which case the total amount of interest paid will decrease.

The interest rate on consolidation loans is the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest 1/8 of a percent and capped at 8.25%.

It is a common misconception that a student can consolidate only once in a lifetime. Borrowers can consolidate multiple times, so long as each new consolidation loan includes at least one unconsolidated loans. However, reconsolidation does not allow one to ‘relock’ the interest rates on an existing consolidation loan. Once the interest rate on a consolidation loan is fixed, it does not change.

Repayment on a consolidation loan will begin within 60 days of disbursement of the loan, unless the borrower qualifies for an deferment or forbearance.

Who Can Consolidate

The conventional wisdom is that students with bank-based federal student loans (i.e., funded by a bank or other financial institution) can only consolidate their loans during the grace period or after the loans enter repayment. However, there is a loophole that allows students to consolidate their loans while they are still in school by first asking that the loans be put into repayment status early. Once the loans are in repayment, they can be consolidated, locking in the repayment interest rate. After the loans are consolidated, the student asks for an in-school deferment to delay the repayment obligation until after they graduate. (Some lenders will provide the loans with an in-school deferment before consolidating them, in order to allow the loans to lock in the lower in-school rate.)

When a student’s bank-based federal student loans enter repayment status early, the student loses the remainder of the grace period.

Students who will be graduating should not ask their loans to be put into repayment status early, as it is usually better for them to consolidate during the grace period.

Not every continuing student will be able to take advantage of this loophole. For a student to consolidate, there has to be a lender who is willing to consolidate their loans. Most lenders will only consolidate loans for students with loan balances of at least $7,500. Most college freshmen and sophomores may be unable to find a lender willing to consolidate their loans.

Note that if the current holder of a student’s loans is unwilling to give the loans early repayment status, the student will not be able to consolidate the loans while still in school.

This loophole has been confirmed by the US Department of Education. Additional details can be found in the early repayment status FFELP consolidation loophole section.

Direct Loans can be consolidated during the in-school period in addition to the grace period and repayment period. Direct Loan students who consolidate during the in-school or grace periods retain the remainder of the grace period. During the in-school period Direct Loans can only be consolidated with the federal government. After the student graduates the Direct Loans can be consolidated with any lender.

Interest Rate Loophole

If a student consolidates their loans before they enter repayment, the interest rate used is the lower in-school interest rate. Thus, although the rounding up of the weighted average can potentially cost the student as much as 0.13%, a student who consolidates before entering repayment can save as much as 0.6%, a substantial net savings. (The in-school interest rate is 1.7% plus the 91-day treasury bill rate from the last auction in May. During repayment, the interest rate is the 91-day T-bill rate plus 2.3%.) This loophole has been confirmed by an excerpt from the Federal Register and direct correspondence with the US Department of Education. Additional details can be found in the interest rate loophole section.

Thus students with loans from the Direct Loan program should consolidate during the in-school or grace periods to lock in a lower interest rate. Students with federal student loans from a bank or other financial institution should consolidate during the grace period to lock in a lower interest rate. (Note that the early repayment status FFELP consolidation loophole allows continuing students with FFELP loans to lock in the in-school interest rate by having the loans put into an in-school deferment after requesting early repayment status.)

Grace Period Loophole

Although students who request early repayment status to consolidate their loans lose the remainder of their grace period, graduating students who consolidate normally during the grace period may be able to retain their entire grace period. If the lender delays disbursing the consolidation loan until the end of the grace period, the student gets the benefit of the grace period and is also able to lock in current interest rates, even if their grace period ends after July 1. This is because US Department of Education guidance has indicated that lenders can choose the interest rate in effect when the lender received the student’s consolidation application and when the lender disbursed the loan, whichever is lower. (The Department’s guidance is based on ambiguity in the Higher Education Act regarding whether the interest rate on a consolidation loan is based on the interest rates in effect when the borrower applies for the consolidation loan or when the lender disburses the consolidation loan. The repayment obligation begins within 60 days of the disbursement of the consolidation loan, per 428C(c)(4).) If the student submits the consolidation application before July 1, and the lender disburses the payoff amounts to the current holders of the student’s loans at the end of the grace period, the student gets to lock in pre-July 1 interest rates and also retain the remainder of their grace period.

Single Holder Rule Loopholes

The single holder rule is an anticompetitive rule that limits a student’s choice of lenders for consolidation. If all of a student’s FFELP loans are with a single lender, they must consolidate with that lender. If the student has FFELP loans with more than one lender, they can choose to consolidate their loans with any lender.

There are, however, a variety of loopholes that allow a student to bypass the single holder rule. There are also several loopholes that might allow a continuing student to consolidate their loans while still in school even if their lender does not cooperate in granting early repayment status to their loans. These single holder and early repayment status loopholes include certifying the inability to obtain (acceptable) income-sensitive repayment terms, consolidating with the Federal Direct Consolidation Loan Program, obtaining a Stafford Loan from a different lender, consolidating a Perkins Loan into a FFELP consolidation loan (or obtaining early repayment status on a Perkins Loan to qualify as an eligible borrower), and a married couple jointly consolidating their loans. Several of these loopholes have not yet been confirmed as valid by the US Department of education.

Benefits and Caveats

Thus, the key benefits of a consolidation loan include the following:

* Replacing payments on multiple loans with a single payment on the consolidation loan.
* Access to alternate repayment plans, such as extended repayment, graduated repayment, and income contingent repayment. Although these plans may be available to unconsolidated loans, the term of an extended repayment plan depends on the balance of the loan, which is higher on a consolidation loan.
* The ability to lock in the interest rate, including the ability to lock in the lower in-school interest rate during the grace period.

There are, however, a few drawbacks to consolidation:

* When a borrower consolidates during the grace period, the borrower has to begin repayment immediately and loses the remainder of the grace period, including possibly interest benefits on subsidized loans.
* The borrower may lose some of the favorable loan forgiveness provisions on the Perkins loan when it is included in the consolidation loan. Perkins loans included in a consolidation loan will also be treated as unsubsidized, meaning that the federal government will no longer pay the interest on the loans while the student is in school.
* Extending the repayment term may increase the total interest paid over the lifetime of the loan.
* Current law allows a borrower to consolidate loans only once. So if interest rates go down, a borrower who had already consolidated will not be able to take advantage of the lower interest rates.
* Lenders who offer borrower benefits for electronic funds transfer and making payments on time tend to offer less favorable benefits for consolidation loans.
* Accrued interest on an unsubsidized Stafford Loan must be capitalized when the loan is consolidated.

A married couple can jointly consolidate their loans. Although this may qualify the couple for a longer repayment term and lower monthly payments, it can also cause problems if the couple gets divorced later. By jointly consolidating the student loans, each spouse assumes full responsibility for repaying the debt. It is not possible to split up the debt during a divorce proceedings, so each spouse remains responsible for paying back the loans. If one ex-spouse fails to make a monthly payment, the other ex-spouse is responsible, and his/her credit record is affected. Similarly, the loan is no longer eligible for an in-school deferment, since both spouses must be enrolled in college for the loan to qualify for a deferment. (If one spouse dies or becomes permanently disabled, however, that portion of the debt is forgiven.) For these reasons, a couple should think twice before jointly consolidating their student loans.

Some graduate students have found it necessary to consolidate their educational loans when applying for a mortgage on a house.

Consolidating a fixed rate loan, such as a Perkins Loan, will not save you any money on the fixed rate loan. Consolidating does not reduce the underlying rate of a fixed rate loan, although it can increase it slightly, due to the rounding up to the nearest 1/8th of a point. (On the other hand, if the weighted average of the interest rates on the other loans would have resulted in the interest rate being rounded up nearly 1/8th of a point, including a fixed rate loan might mask some of the roundup, indirectly saving a little money. Likewise, if the weighted average was just below the 1/8th of a point boundary, including a fixed rate loan that bumps it over the 1/8th of a point boundary could increase the interest rate by up to 1/8th of a point beyond what it would have been otherwise. Thus including a Perkins Loan in a consolidation loan can cause the interest rate to be up to 1/8th of a percent higher or lower than it would otherwise have been, depending on whether it moves the weighted average of the interest rates closer to or beyond the next 1/8th of a percent boundary.) However, many banks provide a 0.25% reduction in the interest rate for signing up for automatic bank debit, which may make consolidating a Perkins loan financially worthwhile.

For More Information

To find out more about Loan Consolidation, call your lender. FinAid maintains a list of education lenders who offer federal and private student loans, including consolidation loans.

If your school participates in Direct Lending, you should visit the US Department of Education’s Federal Direct Consolidation Loan web site instead.

Alternatives to Consolidation

Consolidation simplifies the repayment process but does involve a slight increase in the interest rate. Students who are having trouble making their payments should consider some of the alternate repayment terms provided for federal loans. Income contingent payments, for example, are adjusted to compensate for a lower monthly income. Graduated repayment provides lower payments during the first two years after graduation. Extended repayment allows you to extend the term of the loan without consolidation. Although each of these options increases the total amount of interest paid, the increase is less than that caused by consolidation’s rounding up the interest rate to the next 1/8th of a point.

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