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Student loan refinancing vs. consolidation: Only one actually lowers your interest rate

Here's the difference between consolidating your federal student loans versus refinancing them.

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When you have more than one student loan, monthly payments can be hard to manage. You have to keep track of the various loan amounts, their different interest rates and their separate due dates each month.

There are options to combine your multiple student loans into a single loan, making it so you only have to manage one monthly bill and payment.

Borrowers who decide to consolidate their federal loans with the government do so through the Direct Consolidation Loan program. While consolidation can certainly streamline your payments, however, refinancing is another option that can also provide the same simplified repayment and give you a lower interest rate.

Below, CNBC Select breaks down each.

Student loan federal consolidation

Borrowers can combine their federal student loans through a Direct Consolidation Loan to get one single student loan. Even though their student loans are consolidated, borrowers still have access to the same protections that they had on their old loans, such as student loan forgiveness and income-driven repayment plans. This is a perk of consolidating your federal loans through the government.

Federal consolidation also allows borrowers to choose their new repayment terms, and it doesn't require that applicants have to good credit to qualify (which you need if you want to refinance). The interest rate is a fixed rate, and it's calculated as the weighted average of your original loans' rates. If you're looking for a lower interest rate, you'll need to refinance.

Student loan private refinancing

By refinancing, student loan borrowers replace their current private and/or federal loans with one entirely new loan through a private lender of their choice.

Student loan refinancing includes consolidation in that as a result of the process, you combine your federal and/or private loans together into one payment.

Refinancing is different from federal loan consolidation, however, in that borrowers have the opportunity to get a lower interest rate and reduce the cost of their loans. Lenders usually look at several factors to determine a borrower's refinanced rates, including their credit score, income, debt-to-income (DTI) ratio, savings, payment history on their current student loans and their overall financial health. Borrowers can choose whether to have a fixed or variable interest rate.

Similar to federal consolidation, borrowers who refinance can also choose their repayment terms, depending on how fast they want to pay off their loans.

Those looking to refinance their student loans but may not have the credit to qualify can opt to have a co-signer. Some lenders will even allow the co-signer to be removed after a period of consecutive, on-time monthly payments.

While refinancing could lead to a lower interest rate, you'll lose any protections you have with federal student loans, like income-driven repayment plans and student loan forgiveness. And right now, with federal student loan repayment and interest accrual on pause, it's not the best time to refinance federal loans.

Bottom line

If you want to combine your federal student loans solely to make managing your payments easier, going through the government's Direct Consolidation Loan program is the best answer. This way, you consolidate your loans while also ensuring you don't lose any of their federal benefits.

On the other hand, if you have private student loans with high interest rates, you'll want to go the refinancing route. By refinancing through a private lender, you save money over the life of your loan while still streamlining your monthly payments. Some private lenders offer their own protections, such as deferment and forbearance, so make sure you shop around before applying.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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