How Student Loan Consolidation Works

Brent Earsley, a student loan representative at the Bank of North Dakota in Bismarck, N.D., works at updating loan information files.
Brent Earsley, a student loan representative at the Bank of North Dakota in Bismarck, N.D., works at updating loan information files.
AP Photo/Dale Wetzel

It's estimated that more than half of all college students graduate with debt, and we're not talking about a paltry few thousand on the credit card, either. Given tuition at some of the more prestigious universities can top more than $50,000, and even a community college two-year degree can cost more than $15,000, college debt can be serious and life changing.

Think about it. You borrow $15,000 at 6.8 percent per year to pay for a two-year degree in automotive technology. When you graduate, you'll have 10 years to pay, or roughly 120 payments of $172 and change. When you're done you'll have shelled out roughly $20,000 to pay for the loan and interest.


Now up the ante. Shoot for the four-year degree at an expensive university or college. According to statistics, you'll likely have about $50,000 in loans at the end. With the same interest rate and loan payment period, you're looking at a monthly payment of about $575 and total interest of about $20,000 for a total principal and interest of $70,000.

While the payment is daunting enough, you're likely to end up with several different loans, all with different payment times, rates, structures and formulas. And like any loan, especially in this economy, your "note," or the loan itself, stands a good chance of being bought and sold, so midway through one loan you may suddenly see another loan company holding your note and changing the playing field.

This is where student loan consolidation comes in. In short, it's a way of grouping disparate loans under one umbrella and making a single payment to one entity that's something like an average of all the loans. But "consolidation," while having a specific meaning, is more of a general industry term and can be used for a few different strategies.

While consolidation can be a good idea for some, and at the same time a bad idea for others, it typically serves to make things a little simpler, maybe cheaper, and that's definitely worth looking into. So read on for more information on how to consolidate student loans, and don't be surprised if at the end of this schooling you have a second, informal education in the Byzantine world of student loans.


What is Loan Consolidation?

Financial professionals define loan consolidation as the purchase of several different loans by one company to create one larger single loan. This idea behind this is the company buying the loans purchases them from the other companies at an agreed price, say 80 cents on the dollar. The selling companies make a little money; perhaps less than they would have if they'd kept the loan through its whole period, but still something of a profit. The new company now has a series of debts that need to be paid -- but remember, they bought the debts for a discount price. They levy their interest rate and payment schedule, and the borrower pays them that new interest rate as well as paying off the principal. Perhaps the interest rate is reduced, but then again the new company owning the debt bought it cheap.

The system works the same in the student loan world except the intent is usually more altruistic. The loans are floated or offered by companies that are often publicly held and government-backed. Companies that want people to get an education and use the interest from issued loans to help more students through school.


With the same essential system student loan consolidation should work the same -- and it does, but there are wrinkles. There are dozens of types of student loans and loan issuers. Each one has different rates and structures that set down how the loan is disbursed, or given out, and how the loan is repaid. This makes true consolidation possible, but difficult.

The financial world has also changed. True loan consolidation takes a large amount of free capital. In other words, it takes a lot of financial resources to buy and reissue a loan. Most companies today don't have those resources, or perhaps they focus them in other ways. For example, Sallie Mae, one of the country's larger publicly-held, but private education loan companies, did away with true consolidation in 2009. Its rationale was to use the free capital it had to continue issuing new loans rather than helping buy and repackage old loans, thereby giving more new students a chance at funding higher education.

Instead, Sallie Mae offers several repayment options that will group loans together, and they will help a student set up one payment that covers all the loans, but they won't buy any older loans. This trend of repackaging finances may indicate the future for students and hold some advantages, as well as disadvantages.

Why Consolidate?

The bewildering array of student loans often necessary to fund a few years of higher education means a graduate will walk with a small diploma and a large, complex debt. Consolidation can make dealing with the mechanics of the debt easier.

  • Consolidation offers the advantage of having to pay just one entity rather than several lenders.
  • Consolidation offers access to several repayment plans -- from extended payment plans, to graduated, to income-sensitive and income dependent options.
  • Consolidation reduces the rate on certain loans, and allows for the choice of a potentially better rate by choosing a different lender.
  • It resets the clock on some deferred loans and some loans in forbearance. It also restarts the loan repayment time.

What all this boils down to, without getting into the fine details, is that you're getting a new loan. With federal loans there's generally no cost associated with generating a new loan. However, this isn't so with private student loans, which may have costs associated with consolidation that outweigh the benefit. Private loans are also sometimes tied to the customer's credit rating and a poor credit rating can mean higher consolidation fees, and higher interest rates.


And again, the creation of a new loan is best considered from an information-rich standpoint. For example, let's say a student is within a year of paying off his or her college loans and suddenly hits economic tough times. The student can consolidate the loans, reduce the monthly payment amount by $20 and extend the payments by two years. At the end of that time he or she will likely have paid about $1,000 more in interest and principal, all to save about $500. In that case consolidation would be a bad idea.

However, even non-traditional loan consolidation requires certain criteria to be met, and those criteria are as different as each loan.

Consolidation Eligibility

Jason Lewis, a student at Middle Tennessee University, picks up student loan information at the campus financial aid office in Murfreesboro, Tenn.
Jason Lewis, a student at Middle Tennessee University, picks up student loan information at the campus financial aid office in Murfreesboro, Tenn.
AP Photo/Mark Humphrey

Before considering student loan consolidation, either a traditional type or one of the new flavors, a person has to find out if they're eligible. If they are, they also have to be in the right time frame within the loan life to take advantage of consolidation. So, when exactly is that time?

Well, like the financial professionals say, it all depends. Loans, issuers, servicers and the various financial hangers-on all have different rules regarding consolidation and when it can happen and who it can be offered to. For example, Sallie Mae only offers grouping of certain loans to customers with more than $30,000 in debt. However, it can and does work with customers with less debt to help them accomplish something like consolidation, including helping them shift payments to a single date or working with lenders to extend payments. They're also developing new loan products to keep customers out of financial hot water. For instance, one requirement is the payment of interest on the loan begins when the student or customer enters school.


So when (and if) student loan consolidation is possible is something each customer needs to look into on an individual basis. But there are a few general tips to following when considering loan consolidation:

  • Loan consolidation is best considered when the loans begin coming due, generally six months after graduation, or within the same period of when a student stops attending school. This is also the point when the graduate has an opportunity to see what their financial future looks like and whether it would be better to stick with an agreed on 10-year payout, which offers the least amount of interest paid, or something that would reduce monthly payments but increase the overall cost of the loan.
  • Traditional consolidation was used more when student loan products were tied to the prime rate. If a student borrowed at 6.8 percent, and the prime dropped a year after he or she started paying, the student could apply for consolidation and the new loan would be tagged to the new interest rate, which was hopefully lower. Today, student loans are tied to a fixed rate rather than the variable prime. However, loans issued in 2010 are issued at a lower rate than those issued just a few years earlier and consolidation, if possible, could mean a lower rate.
  • Consolidation can take place any time during the life of the loan, but often the number of times a loan can be consolidated is limited. A change in financial circumstance can mean a needed change in the loan. The key is to keep an eye on how the loans fit into an individual's budget and how a consolidation may benefit the customer.

Overall, weighing your economic situation versus the terms of the loan is beneficial in looking at the times when you may not want to consolidate your loans. In the next section, we'll examine some of the downsides of consolidation, and why it's good to have that information on hand before making any decisions.

The Downsides of Loan Consolidation

Some of the advantages were covered on other pages, but there are a few possible downsides to student loan consolidation that we need to mention, too. For example, extending payment time or restructuring a loan can mean more money paid over the long-term or accruing fewer benefits from paying through traditional channels.

Here are a few things to consider before consolidating student loans:


  • You lose any grace period built into a loan structure if you consolidate too early. Let's say you decide to lump all your loans together the month after leaving college. The interest rate drops a tiny bit, but before your resume even reaches prospective employers, you have to begin paying your loans. Remember, consolidation rests the loan clock -- sometimes for the better and sometimes for the worse.
  • Certain loans, like the Perkins loan, have interest benefits within a tax structure. When you consolidate a Perkins loan, you lose those benefits, as well as the grace period, if consolidation occurs early.
  • You may adversely affect your extended repayment options.
  • You can only consolidate student loans a limited number of times -- usually only once.

Loan consolidation is never cut and dried. It's a financial tool that comes with risk, and you have to determine how that tool is properly used to use it to your benefit. In addition to the above considerations, there are other smaller yet still significant concerns as well.

Many lenders offer interest reductions and discounts for using electronic debiting, timely payment and other incentives for keeping up with payments. These benefits often evaporate under consolidation. Sometimes the way interest is accrued will change as well.

Finally, because of changes in lending, many lenders and loan servicers offer the same benefits of consolidated loans, like extended payment plans, without consolidation.

The best way to understand the advantages and disadvantages is to talk to a financial professional, or someone who understands the ins and outs of student loans. The sources listed on the next page will serve to point a parent and a student in the right direction, but it will take a little time and effort to learn how the system really works and how it can work specifically for you.

The best advice is to understand what you will be paying before you even consider student loan consolidation. As they said in high school, "Don't forget to do your homework." In this case, it just may get you on your way to a better financial future.

For more information about loan consolidation and other related topics, follow the links on the next page.

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  • Christel, Patricia Nash. Managing Director of Communications for Sallie Mae. Personal Interview. Conducted on March 18, 2010.
  • FinAid. (April 15, 2010)
  • Sallie Mae. (April 15, 2010)
  • U.S. Department of Education. "Direct Consolidation Loans." (April 15, 2010)
  • U.S. Department of Education. "Federal Student Aid." (April 15, 2010)