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by Peter Wilkniss | March 10, 2009

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The cost of a college or graduate school education just keeps going up. So much so that the average college student graduates with over $20,000 in student loans and many business, law and med school grads end up carrying around $100,000 or more of student loan debt. Pretty intimidating as you start your career - kind of like having a mortgage, but without the house.

Here's the good news: your student loans are some of the cheapest and most flexible debt you will ever have. And, there are tools available to help you fit your student loan payments into your lifestyle and career goals, rather than the other way around.

One popular student loan debt management tool that you may have heard something about is student loan consolidation.

As you will see below, there are two very different types of student loan consolidation programs: one for federal student loans and one for private student loans (sometimes also called alternative student loans). While these two programs do differ in many ways, they share the goal of helping you reduce your monthly student loan payments, particularly in the early years as you begin your career.

Federal Student Loan Consolidation

The Federal Student Loan Consolidation Program is authorized by the Higher Education Act of 1965, the same federal law that allows for your current federal loans. The government established the Federal Student Loan Consolidation Program specifically to help graduates better manage their student loan payments. Most federal consolidation loans are made by private sector lenders - many of the same lenders that make the types of student loans you currently have - and are guaranteed and subsidized by the federal government.

As you can see from the chart below, consolidating your federal loans can significantly reduce your monthly payments.

Monthly Savings of Borrowers Who Consolidate Federal Student Loans*
Current Loan Amount$25,000$50,000$75,000
Estimated Monthly Payment Before Consolidation$288$575$863
Estimated Monthly Payment After Consolidation$188$341$480
Monthly Savings$100 (35%)$234 (41%)$383 (44%)
*The Estimated Monthly Payment Before Consolidation assumes a 6.8% interest rate under the standard 10-year repayment plan. The Estimated Payment After Consolidation is calculated under the Level Repayment Plan using an interest rate of 6.825% with extended payment terms and borrower benefits applied. Actual rate and payment may vary.

How Federal Loan Consolidation Works

With a federal consolidation loan, your existing federal loans are refinanced with one new federal loan - not unlike refinancing a mortgage.

By consolidating, you combine your multiple federal student loans into one federal loan with a single monthly payment and lock in a fixed rate on your variable rate federal loans (federal student loans taken out prior to July 1, 2006 carry variable interest rates that are reset every July 1, based on market interest rates. Federal student loans taken out after July 1, 2006 carry fixed interest rates.).

By consolidating you can also extend the repayment term on your federal student loans to up to 30 years (the repayment term on federal Stafford loans is 10 years). Extending your repayment term will reduce your monthly payments significantly. Of course, stretching out payments means paying more interest over time, but a federal consolidation loan can always be repaid early without penalty.

Even if you are happy with your current payments you can benefit from consolidation by directing your monthly savings elsewhere. Taking your consolidation savings and paying off higher interest rate credit cards or private student loans will save you money immediately.

Consolidating your loans can also improve your chances of being approved for a mortgage or car loan. Lowering your monthly student loan payments means that less of your monthly income will go toward paying debt, reducing your "debt-to-income ratio." Your debt-to-income ratio (the lower, the better) is one of the factors a mortgage or car loan lender will look at in determining how much you can borrow.

There are no fees, no credit checks and no employment verifications to apply for a federal consolidation loan. In fact, the government prohibits federal consolidation lenders from charging fees.

The application process can be completed in a matter of minutes online or over the phone. All that is required is a short federal application, basically containing some personal information, contact information for 2 personal references and information on your current student loans, which your lender can fill in for you. Virtually everyone with federal student loans qualifies for a federal consolidation loan - as long as they have over $7,500 in federal loans and aren't in default on those loans.

You can learn more about federal loan consolidation or apply for a federal consolidation loan with Vault's no-obligation Loan Consolidation Service.

Private Student Loan Consolidation

Just like with federal consolidation, your goal with private student loan consolidation is to reduce your monthly payments by getting as low an interest rate and as long a repayment period as possible (keeping in mind that stretching out payments means you will pay more interest over time and that you should make extra payments whenever possible to pay off the loan faster).

Similar to federal consolidation, a private consolidation lender will pay off your current private student loans and replace them with one new loan. However it is important to note that while federal student loans are guaranteed by the government, private student loans have nothing to do with the government; they are, in fact, just another form of consumer loan (like credit cards or a car loan).

Because private student loans lack a government guarantee, eligibility for a private consolidation loan is based on your credit (or that of a co-signer). The better your credit, the lower the interest rate and the origination fees (if any) and the longer the repayment term.

Your creditworthiness is assessed based on your credit score. The power that this three-digit number has on your life shouldn't be underestimated. In addition to determining your eligibility for a private consolidation loan (and other loans like mortgages), your credit score can determine whether or not you will get a particular job (many employers now check credit scores as part of the hiring process).

Credit scores are calculated on a scale from 300 to 850. Nationwide, the average score is 677. Anything over 700 is generally considered "good". To make matters more opaque, you actually have three scores. Each of the three credit bureaus: Experian (www.experian.com) , Trans Union (www.tuc.com), and Equifax (www.equifax.com), calculates a separate score for you based on information the credit bureau keeps on file about you.

Each private consolidation lender is different, but a credit score of 700+ should qualify you for a loan with pretty good terms. If your score is lower than 700, consider using a co-signer with better credit; most lenders will base their decision on your co-signer's credit.

Unlike federal consolidation, almost all private consolidation loans carry variable interest rates. That is, your rate will go up or down over time depending on movements in market interest rates. Your lender will base your rate on a "benchmark" interest rate (generally, the Prime Rate), plus an additional 0%-7% or so (also called a "margin") depending on your credit; the better your credit, the lower the margin. The Prime Rate is currently 7.75%, so with good credit you can expect a current interest rate somewhere between 8.5%-10%. Origination fees can range anywhere from 0% to 9% and repayment periods can be anywhere from 10 to 30 years, again depending on your credit.

Because each lender will evaluate your credit differently, it pays to shop around and negotiate (just like you would with your credit card company). You can generally get pre-approved over the phone or online in about 10 minutes and you'll usually get a quote on the terms of the loan at the same time.

One word of caution: it is almost never a good idea to consolidate your federal loans together with your private loans. By doing so, you will forfeit many of the benefits the government provides to you on your federal student loans.

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