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Apr 08, 2017 07:57 AM EDT

Finance 101: What Students Should Know About Consolidation And Refinancing

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Finance is already daunting enough with the amount of money that students are supposed to pay after college. Nonetheless, loans are bound to overwhelm both students and parents with all the confusing jargons that they have to face.

An example of confusing concepts in finance is student loan refinancing and student loan consolidation. The two are commonly used interchangeably since both terms allow students to bundle several loans into one.

That's the only similarity, though. Federal consolidation and refinancing, which is also known as private consolidation, are two different processes.

NerdWallet noted that federal consolidation is a process that simplifies federal loan payments. It can also help borrowers be eligible for programs like income-driven repayment plans as well as public service loan forgiveness.

In contrast, refinancing is a way for students or graduates to lower their interest rate and save money on the total cost of their loans. Mixing up the two terms can have financial consequences, not just in the short-term but also in the long-term.

The publication shared a breakdown of how to tell federal consolidation and refinancing apart. Federal consolidation is completed through the government and combines all of one's federal loans under a single servicer of the payer's choice.

The new interest rate will be the average of all the individual rates, rounded up to the nearest 0.125 percentage point. One drawback for this is that it can take up to 20 extra years in interest payments due to an extended loan term.

Those with federal loans are eligible for consolidation. Graduates can apply after they leave school or drop below half-time enrollment.

Refinancing, on the other hand, is completed through a private lender and swaps out the payer's existing loans for a new one with terms based on their financial history. One drawback is that borrower protections on federal loans are lost.

Graduates can qualify if they have a low debt-to-income ratio. It also helps if they have a steady source of income and a credit score in the mid-600s or higher.

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