What’s the Difference Between Student Loan Refinancing and Consolidation?

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Higher education can open the door to better job prospects and a larger salary, but there’s nothing cheap about earning a degree. According to the Institute for College Access and Success, in 2013, about seven in 10 graduates from public and nonprofit colleges had student loan debt with the average student owing $28,400.

If you didn’t attend college with a silver spoon in your mouth and had to apply for financial aid (like many students did, myself included), you might be bogged down with multiple loans. This can be a lot to keep up with, but fortunately there’s an easier way to manage student loan debt and perhaps pay it off sooner. In fact, some post-grads have successfully managed their debt with student loan refinancing and consolidation.

These terms are sometimes used interchangeably. But while they can serve a similar purpose, consolidation and refinancing are not the same.

What Is Student Loan Consolidation?

Consolidation is the process of combining or merging multiple loans into a single one. A student loan consolidation can combine all your federal loans into one loan at no cost. Some students pay for their entire college education with only one type of federal loan, but others receive funds from multiple federal loans. For example, you might have a Direct Unsubsidized Loan, a Direct PLUS loan, and perhaps another type of federal loan. This can become a headache at best, and it’s easier to overlook a bill when you receive so many statements each month.

Consolidation simplifies the way you manage your student loans. Combining your federal loans into a single loan means you’ll only have one monthly statement, one due date, and one set of loan terms, which usually includes a low, fixed interest rate.

Federal student loan consolidation is offered by the U.S. Department of Education and it’s only for federal student loans — not private loans. So if you have a mix of federal educational loans and private educational loans, you cannot consolidate through the Department of Education.

This doesn't mean you can’t simplify and merge your federal and private loans into one loan. This is still an option, but instead of Federal consolidation, you have to refinance your loans through a private lender, such as a bank or credit union.

What Is Student Loan Refinancing?

Refinancing involves applying for a new loan (sometimes with a lower interest rate), and then using these funds to pay off existing loans. Refinancing is only available through private lenders. This is a smart move if you have multiple private loans with variable interest rates and you want a fixed interest rate, which can protect you from rate hikes in the future and potentially save you money.

Since refinancing is through a private lender, you have to complete a loan application and go through the underwriting process, at which point a lender evaluates your credit history and income to determine if you’re eligible. If you qualify, refinancing can help you get a lower interest rate, which can save you money over the life of the loan. A lower payment can create more cash flow, and you can use the savings to pay off other debts, move out of your parents’ house, or build your emergency fund. Refinancing also helps pay off student loan debt faster, especially if you're able to make higher payments. This is because more of your payments will go toward reducing the principal.

Refinancing is the only way to combine your federal and private loans into a single loan. But it’s important to note that refinancing a federal loan involves giving up some protections offered by government loans.

For example, federal loans have provisions to help students manage their debt, such as income-based repayment. And if you experience economic hardship like the loss of a job, federal loans give the option of forbearance or deferment. Both options allow borrowers to stop making payments on a temporary basis. Some private lenders don't offer such perks. So while refinancing can simplify your financial life, make sure you have a strong financial foundation before switching federal loans to a private loan.

Did you refinance or consolidate your student loans? How did it improve your situation? I’d love to hear about your experience in the comments section.