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Using a Refinance or Consolidation to Simplify Bill Payments is Dumb

Streamlining student loan repayment has its advantages, but using a refinance or consolidation for this purpose is asking for trouble.

Written By: Michael P. Lux, Esq.

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Affiliate Disclosure and Integrity Pledge

Temporary Forgiveness Clock Rule: The Department of Education is conducting a one-time update of IDR payment counts. Borrowers who consolidate their federal loans before June 30, 2024, can maximize progress toward PSLF and IDR forgiveness.

Both federal student loan consolidation and private student loan refinancing have significant advantages. These two processes can easily save borrowers thousands of dollars when done correctly.

However, both federal consolidation and private refinance come with significant risks. The potential dangers are part of the reason that I hate to see people describe a streamlining of payments as a benefit to refinancing.

In theory, going from three payments with three different lenders into one single monthly payment does sound better, but it isn’t. Borrowers are exposed to the risks of refinancing (or consolidation in the case of federal loans), and they lose out on some potential valuable repayment strategies.

Going from Multiple Monthly Payments to a Single Bill Isn’t a Big Deal

In the era of calendar reminders, electronic banking, and automated bill pay, the notion of combining payments for convenience seems antiquated. It isn’t like you have to run to the post office to buy stamps, sign checks, and mail in a bill to each lender every month.

In many cases, lenders may even offer a slight discount for borrowers who set up automated payments. While there are concerns with giving the student loan company access to your checking account, the point is that the procedure for making payments is really simple these days.

There are many valid reasons to refinance or consolidate. Refinancing can get lower interest rates and a smaller monthly bill. Federal consolidation helps convert federal debt into loans that are eligible for better repayment plans and forgiveness programs. The argument here isn’t that it is bad to consolidate debt. Rather, combining loans just for the sake of reducing the number of monthly payments is a mistake.

The Perk of Several Smaller Loans

Having multiple, smaller loans may sound like a headache, but it comes with some real advantages.

One of the biggest perks is that borrowers can focus their efforts on the loan with the highest interest rate. Extra payments can be used to eliminate the most expensive loan, making the remaining repayment significantly easier. Focusing on a single high-interest loan can be worth thousands of dollars.

Those who go through federal direct consolidation will have a single larger loan with an interest rate based upon the weighted average of the smaller original loan. In other words, rather than attacking the highest interest loan, borrowers are stuck with a larger medium interest loan for the duration.

Having Many Low Balance Loans Can Make Buying a House Easier

When a lender makes a decision on a mortgage application, one of the most important numbers that they look at is the applicant’s DTI or debt-to-income ratio. The DTI looks at the monthly income of the applicant and compares it to the applicant’s monthly bills.

One large loan with one large monthly payment can be a major hardship. Paying extra towards the large loan will lower the balance, but it doesn’t change the monthly payment. No monthly payment change means no DTI improvement.

With several smaller loans, extra payments can be used to entirely eliminate one of the loans. When a loan is completely eliminated, it falls off a credit report, and the DTI is improved. The better DTI number allows the mortgage applicant to potentially qualify for a larger home loan.

This particular perk is complicated by the fact that refinancing and consolidation both can potentially change monthly payments due to a new interest rate or repayment length. Thus, it is possible that a refi or consolidation can help a mortgage applicant’s DTI, but it isn’t a certainty.

It would be a mistake to blindly combine loans just for ease of monthly bill writing when the DTI implications are far more significant. If refinancing or consolidation can help, it is great, but a borrower can’t know until they run the numbers and consider the consequences.

Ease of Bill Pay is a Pet Peeve

The point of this article is not to suggest that private student loan refinancing or federal direct consolidation are to be avoided.

Refinancing can help lenders save a small fortune on interest. Federal consolidation can potentially open the door to student loan forgiveness programs and better repayment plans.

Both refinance and consolidation also come with risks. Refinancing a federal loan into a private loan could mean losing out on important federal protections. Consolidation can also restart certain forgiveness clocks and/or cause borrowers to lose eligibility for some repayment plans.

These are major issues with major consequences. These major consequences should be driving the decision making.

A borrower who refinances or consolidates purely to streamline their monthly bills is overlooking the essential considerations. Therefore, ease of bill pay should not be a factor when deciding whether or not to refinance or consolidate.

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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