Consolidation Loans combine several student or parent loans into one bigger loan from a single lender, which is then used to pay off the balances on the other loans. It is very similar to refinancing a mortgage. Consolidation loans are available for most federal loans, including FFELP (Stafford, PLUS and SLS), FISL, Perkins, Health Professional Student Loans, NSL, HEAL, Guaranteed Student Loans and Direct loans.
The interest rate on a Consolidation Loan is fixed for the entire life of the loan and is based on the weighted average interest rate of the loans being consolidated (as reported by the loan holder(s)), rounded up to the nearest 1/8 percent and capped at 8.25%. (See below for the PLUS Loan Loophole created by recent new legislation.) For borrowers with variable rate Federal Stafford loans who submit a consolidation application during their grace period, the interest rate of the Consolidation Loan will be based on the relatively lower grace period interest rate as reported by the loan holder.
For example, suppose a student has just Stafford Loans originated on or after July 1, 2006. These loans have a fixed interest rate of 6.8%. When they are consolidated by themselves, the consolidation loan will have an interest rate of 6.875% or of 6 and 7/8ths of a percent. So the interest rate increases slightly. However, with a longer repayment period, the monthly payments are lowered and become more manageable. This is an important concern during the early career years when income is generally at its lowest. It is also important to note that with federal student loan consolidation there is no penalty for early payments. In other words if you decided that you wanted to pay off your debt you could do so without any penalty. On a money management basis you would pay off higher interest rate debt first before paying off your consolidation loan.
If the you have a mix of loans with different interest rates, the weighted average will be somewhere in between. For example, if the you have $5,000 of Perkins Loans (at 5.0%) and $10,000 of Stafford Loans (at 6.8%), the weighted average is calculated as follows:
$5,000 * 5.0% + $10,000 * 6.8%
------------------------------ = 6.2%
$5,000 + $10,000
This weighted average, 6.2%, is then rounded up to the nearest 1/8th of a percent, yielding a consolidation loan interest rate of 6.25%.
The weighted average does not fundamentally alter the underlying cost of the loan. It preserves the cost structure by including each interest rate to the extent that it applies to part of the overall loan balance. For example, the consolidation loan in the previous paragraph says that of the $15,000 consolidation loan balance, $5,000 will be at 5.0% and $10,000 at 6.8%, yielding an equivalent interest rate of 6.2%.
If you were deferring the interest on an unsubsidized Stafford Loan by capitalizing it, most lenders will add the capitalized interest to principal when you consolidate. (Lenders can capitalize interest at most quarterly, but most capitalize it once when the loans enter repayment or at other loan status changes.)
The PLUS Loan Loophole: The PLUS loan interest rate loophole can reduce the interest rate on 8.5% fixed rate PLUS loans by 0.25% through consolidation and this doe not include any borrower incentive rate discounts.
With the PLUS Loan Interest Rate Loophole, you can use consolidation to reduce the interest rate on 8.5% fixed rate PLUS loans by 0.25%. The Higher Education Reconciliation Act of 2005 increased the interest rates on PLUS loans starting July 1, 2006, to a fixed rate of 8.5%, but left the interest rate formula on consolidation loans unchanged. In particular, it left the cap at 8.25%. So a PLUS loan borrower can reduce the interest rate on a PLUS loan by 0.25% simply by consolidating it, so long as the PLUS loans are consolidated by themselves.
You don't want to include other types of loans in the consolidation loan because the weighted average will reduce the interest rate before applying the cap. Consolidating PLUS loans by themselves maximizes the impact of the 8.25% cap.
There are no reasons why a parent or graduate/professional school graduate shouldn't consolidate a PLUS loan. It is recommended that all borrowers of 8.5% fixed rate PLUS loans consolidate them to reduce the interest rate. Parents of undergraduate students will be able to consolidate them soon after the PLUS loan is fully disbursed. Graduate and professional students, however, will need to wait until they graduate to consolidate, since in-school consolidation was repealed effective July 1, 2006. Since PLUS loans do not have a grace period, there is no reason to not consolidate them.
IMPORTANT NOTE: As with all consolidations, it is vital that you consult with an experienced, knowledgeable, trustworthy consolidation counselor/specialist who will answer all of your questions and inform you of all of your options. Consolidation is very personal because it is based upon each borrower’s unique individual circumstances: amounts borrowed, loan types, personal and professional goals and attitude and tolerance for debt. MEDebt Solutions Program counselors are committed to assisting physicians-in-training in understanding consolidation and how it best works for you; whether you use the program or not.
Source: FinAid.com - http://www.finaid.org/loans/consolidation.phtml
