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Student Loan Refinancing vs. Consolidation: What's the Difference?

Matthew Frankel, CFP, The Motley Fool

Refinancing and consolidation are often used interchangeably, but they actually have rather different meanings. 

College graduate hugging his parents

Image source: Getty Images.

When it comes to student loans, the terms refinancing and consolidation are often used interchangeably, as both generally involve combining several student loans into one. However, it’s important to realize that they actually have significantly different meanings.

Refinancing versus consolidation

The short version is that refinancing refers to obtaining an entirely new loan in order to pay off existing loans. When you refinance loans, you’ll need to go through a new loan application process and will likely have to agree to a credit check, income verification, and other assessments of your qualifications. Based on how well-qualified you are, your new loan will be given a new interest rate -- that is, the interest rates on the loans being refinanced play no part in determining your new interest rate.

You’ll obtain a new loan and its proceeds will be used to pay off your specified existing loans. When you refinance student loans, the new loan proceeds are typically sent directly to your existing student loan servicers.

On the other hand, student loan consolidation means combining your existing student loans into one. The most common form of student loan consolidation is a Direct Consolidation Loan, which is used to combine multiple federal student loans into one. While you’re technically obtaining a new loan, you don’t have to go through a new underwriting process -- your consolidation loan’s interest rate will simply be a weighted average of the interest rates on your existing loans.

For a simplified example, if you consolidate two $10,000 federal student loans, one with a 5% interest rate and the other with a 7% interest rate, you’ll receive a $20,000 consolidation loan with a 6% interest rate.

Why you might want to consolidate your student loans

Consolidation can be a good move for many federal student loan borrowers. The most obvious reason to consolidate is to simplify your repayment.

As a personal example, when I obtained my bachelor’s degree, I had a total of six federal student loans. Three of them were subsidized loans and the other three were unsubsidized. Not only did I have six, but they were serviced by two different companies, so I had to send checks (this was before electronic payment was popular) to two different places. By obtaining Direct Consolidation Loans, I combined my federal student loans into one easy-to-understand bill and only had to send one check.

It can also be a smart idea to consolidate if you have any federal student loans that aren’t Direct Loans and you work in public service. Federal Stafford Loans, Federal Perkins Loans, and PLUS Loans are some examples. On their own, these loans don’t qualify for Public Service Loan Forgiveness (PSLF), but after you combine them into a Direct Consolidation Loan, they do.

Why consolidation might be a bad idea

On the other hand, there could be good reasons not to consolidate. One big reason is if you’ve already been making qualified payments toward PSLF or on an income-driven repayment plan. These loan forgiveness programs require a certain number of payments, and by consolidating, you’ll lose credit for any qualifying payments you’ve already made.

It’s important to mention that consolidation isn’t an all-or-none choice. You can choose not to include certain loans in a Direct Consolidation Loan.

How to consolidate your student loans

If you decide that consolidating your federal student loans is the best move for you, the application is available online at StudentLoans.gov. As part of the application, you’ll select a consolidation servicer, who will process your loan consolidation. One important point: Until you’ve received confirmation that your existing federal student loans have been paid off by your new Direct Consolidation Loan, you need to keep making payments on them.

Why you might want to refinance your student loans

As I mentioned, refinancing means obtaining an entirely new loan to pay off your existing student loans. Refinancing is done through private lenders, and while most people who refinance student loans have more than one to pay off, there’s no reason you can’t refinance a single student loan if you want to.

There are several reasons why refinancing your student loans through a private lender can be a smart idea:

  • Most obviously, you can potentially lower your interest rate. There are some private lenders who offer highly competitive APRs on refinancing, with both fixed and variable interest rates, especially for borrowers with strong credit scores.


  • You may be able to lower your monthly payment. For example, if your existing student loans have a 10-year repayment term and you refinance them into a loan with a 20-year term, even if your interest rate stays the same, your monthly payment will drop significantly.


  • Just like with consolidation, refinancing can help make your financial life simpler. This is especially true if you’re refinancing loans that you obtained through more than one lender, and you’re currently having to make multiple loan payments each month.


  • Refinancing can be a good option if you have a cosigner on your existing loans and want to get their name off of them. If you feel that your credit and income qualifications are good enough to justify refinancing a loan in your own name, this could be a way to release your cosigner from the legal obligation.

Why refinancing might be a bad idea

While refinancing student loans is certainly a smart move for many borrowers, it isn’t the best choice for everyone. There are some good reasons why you might not want to refinance your student loans.

First and foremost, it’s typically a bad idea to refinance federal student loans through a private lender. Federal loans have some unique advantages, such as the ability to qualify for income-driven repayment plans and loan forgiveness programs, as well as generally having more flexible deferment and forbearance options than private loans. While it isn’t always a bad idea, I’d suggest thinking long and hard before using a private lender to refinance your federal loans.

Additionally, it can be a bad idea to refinance if your existing student loans already have a competitive interest rate or have some valuable features you don’t want to lose.

How to refinance your student loans

There are a growing number of private companies that specialize in student loan refinancing. If you’ve decided that student loan refinancing is the right move for you, the best thing you can do is to compare the interest rates and other features offered by several different lenders. Our best student loans page is a great place to start, and most of the lenders on there will let prospective refinancers check their interest rates without affecting their credit score.

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