A federal consolidation loan is a lending package

What Is a federal consolidation loan?

A federal consolidation loan is a lending package designed to combine several education loans into one larger loan. The proceeds of the consolidation loan are used to pay off the smaller balances, and the new loan is recalculated at a fixed interest rate. The repayment term may also be extended beyond the normal ten-year period. While the total amount to be repaid is not reduced, this results in lower monthly payments for the borrower. The process is similar to refinancing a mortgage to obtain easier repayment terms.

Types of loans covered

Most federal student and parent education loans are eligible for consolidation, including Stafford, SLS, PLUS, Direct, Perkins, and Guaranteed student loans. Federal consolidation loans are also available for FISL, NSL, HEAL, and Health Professional Student Loans. Only federal student loans may be combined under a federal consolidation loan, but many lenders also offer consolidation packages for private student loans.

Who is qualified for a federal consolidation loan?

Almost any borrower may consolidate his or her federal education loans. In order to consolidate, the loans must be in their grace period or already in repayment; loans in default may also be consolidated if acceptable repayment terms have already been negotiated on the overdue balance. Loans in deferment may not be consolidated until the deferment period has expired.

Consolidation loans are confined to a single borrower of the original loans. Consequently, while consolidation loans are available for both student and parent loans, parent and student loans cannot be combined into one package. Likewise, married couples cannot consolidate their loans into one package - they must be repaid separately.

If a loan is in its grace period, the grace period ends at the time of consolidation.

In addition, a loan may be consolidated only once. A borrower may consolidate two consolidation loans, or re-consolidate a consolidation loan by adding a new loan, but an existing consolidation loan may not be refinanced. A borrower may not re-consolidate a consolidation loan by switching lenders; once a borrower has received a consolidation loan, the loan is locked in with that lender for the entire repayment term.

Fees and interest rates

There are no additional fees associated with federal consolidation loans. Lenders are not authorized to charge any fees in conjunction with a consolidation loan, and if a lender states that an origination fee is required, it is best to look elsewhere for a loan.

Different interest rates are associated with each type of federal student loan. When consolidating the loans, a new interest rate is calculated based on a weighted average of the existing interest rates and may not exceed 8.25%. The interest rate then remains fixed throughout the life of the loan.

Repayment plans

The standard repayment term for federal education loans is 10 years. However, with a consolidation loan, this period may be extended (up to 30 years in some cases). Some of the alternate payment plans include graduated repayment, income contingent repayment, and income sensitive repayment. Even in cases where the repayment term of a loan was less than ten years, this term may be extended, resulting in a lower monthly payment.

How to find a lender for a federal consolidation loan

Most lenders offer one or more federal consolidation loan packages. When searching for a consolidation loan, it is important to shop around and compare different options. Not all consolidation loans offer the same incentives, and in some cases it is actually more advantageous to continue with the original loan. Federal student loans often provide loan discounts and incentives which make the original loan less expensive than a consolidation loan.

Lenders actively seek out borrowers for consolidation loans, and students nearing graduation quite often receive many offers for federal consolidation loans. Again, it is necessary to weigh the benefits offered by each lender and calculate the total cost of the loan before deciding on a particular package.

Advantages and disadvantages

The advantage to consolidating federal student loans, of course, is that the monthly payment amount is normally lower than the combined payments on several loans. The lower payments make it easier for a borrower to meet the required monthly amount, and there is no prepayment penalty for federal consolidation loans.

However, the pitfall is that the total cost over the entire term of the loan can be much higher. While the interest rates on some of the loans are reduced, others will be increased. If the repayment term is extended beyond the standard ten-year period, the total interest paid over the life of the loan will be greater.

When considering a federal consolidation loan, borrowers must weigh all options carefully and determine if the terms of the consolidated loan are preferable to those of the original loans.