How to Consolidate Your Student Loans: Complete Guide

Are you feeling burdened with student loans? Consolidating your loans might help you turn over a new leaf.

Student loan consolidation can simplify your monthly payments and potentially reduce your interest rate, resulting in a lot of savings in the long term. At the same time, loan consolidation isn't for everyone, so you need to make sure you understand all the terms before taking on a new contract.

This guide will go over the ins and outs of student loan consolidation so you know what it means, how to do it, and whether or not consolidating your student loans will give you a fresh financial start. First, what exactly is student loan consolidation?

What Is Student Loan Consolidation?

Student loan consolidation, a way to refinance student loans, bundles all of your student loans together and combines them into one new loan with a single monthly payment and a new interest rate. Ideally, that interest rate is lower than the ones you're currently paying.

Loan consolidation programs might also offer you more flexible terms to pay off your loans, whether that means buying more time or getting your loans paid off as fast as possible. Either the government or a private lender, like a loan consolidation company or bank, takes some or all of your various loans and distributes a new single loan.

Depending on which entity you use to consolidate your loan, you can consolidate federal loans, private loans, or both. Read on to learn about which loans you can consolidate.

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Federal Vs. Private Student Loan Consolidation

When you take steps to consolidate your student loans, you have two potential avenues - the federal government or a private lender. There are different rules, benefits, and drawbacks for both options, and guidelines further vary among private lenders. Let's look at how each option works, its pros and cons, and how to apply for student loan consolidation.

Student Loan Consolidation From the Federal Government

The US Department of Education offers a Direction Consolidation loan that replaces all of your federal student loans into one loan with a single payment and new terms. To apply for Direction Consolidation loans, your current loans must be in a grace period or repayment.

Federal loan consolidation doesn't usually lower your interest rates much overall. However, it can be useful because it offers more flexible repayment terms and forgiveness options. The reason it doesn't change your interest rates much is that this program uses a new rate that's a weighted average of your old one.

To determine the interest rate of Direct Consolidation loans, the Department of Education takes a weighted average of your current interest rates and then rounds to the nearest 1/8th of a percent. To calculate this weighted interest on your own, you would multiply each loan by its interest rate, add the products together, and then divide by the sum of your loans. Finally, you would round to the nearest 1/8th percent.

There are several calculator tools to help you estimate your weighted average online, or you can crunch the numbers yourself. Consider the following example to learn how to calculate the weighted average of your federal interest rates.

Calculating the Weighted Average of Your Interest Rates: An Example

A Direct Consolidation Loan from the federal government recombines your loans and gives you a new loan with a new interest rate. The student loan consolidation rates are a weighted average of your current interest rates. You can estimate this weighted average in five steps.

Let's say you have one federal loan for $10,000 with a 6.5% interest rate and another for $2,000 with a 5% interest rate.

Loan 1: $10,000 with 6.5% interest
Loan 2: $2,000 with 5.3% interest

These are the five steps you would take to figure out your weighted average:

Step 1: Multiply each loan amount by its interest rate. These products represent the "per loan weight factor."

Loan 1: $10,000 x 0.065 = 650
Loan 2: $2,000 x 0.053 = 106

Step 2: Add the products together. In this example, we have two loans, so we'll add two products together.

650 + 106 = 756

Step 3: Add the loan amounts together.

$10,000 + $2,000 = $12,000

Step 4: Divide the sum from step 2 (the "total per loan weight factor") with the sum from step 3 (the total loan amount). Multiply by 100 to turn the decimal into a percentage.

756 / 12,000 = 0.063
0.063 x 100 = 6.3%

Step 5: Round up to the nearest 1/8th of a percent. The percentage should end in 0.125, 0.250, 0.375, 0.500, 0.625, 0.750, 0.875, or 1.000. If your weighted average already looks like one of these decimals, then you don't need to round up.

6.3 + 0.075 = 6.375%

With our two loans, the new weighted interest rate would be 6.375%. You can see how this is different than a non-weighted average, which would simply be 5.9% ((.065 + .053) / 2 x 100 = 5.9%).

Now that you have a sense of how the government's Direct Consolidation loan works, let's look at the pros and cons of consolidating your loans through the federal program.