Federal Direct Loan Consolidation
The skinny on a “not-so-normal” consolidation option
The word “consolidation” has a pretty consistent definition in lending: take a set of loans and group them into a single loan, using the weighted average interest rate for the new loan.
In Student Loan Land, consolidation usually comes to mind when refinancing a bunch of student loans into a single private loan at a lower interest rate. There are huge tradeoffs to refinancing — mainly the loss of deferment protections and income-driven options if the loans are federal.
As it turns out, there’s a way to consolidate the loans with the government and do the opposite — open up further repayment options!
Direct Consolidation can give the borrower more room to repay!
The Basics
Federal Direct Loan Consolidation works the same way as a normal consolidation with a few differences:
👍 The new loan is a Direct Loan. This qualifies the borrower for new income-driven repayment options such as REPAYE and PAYE.
👍 Direct Consolidation Loans are eligible for PSLF. You can read more about the benefits of Public Service Loan Forgiveness here.
❗️ The repayment schedule is reset. If payments were made on a forgiveness plan with old FFEL loans, those are wiped from the record.
❗️Any outstanding interest is capitalized. If interest has been accruing on the consolidated loans, it’s immediately added to the balance.
Two other interesting things happen:
✅ If any of the consolidated loans are Parent or Graduate loans, the new Consolidated loan keeps track of it for estimating repayment terms.
✅ If any of the consolidated loans were subsidized, the government will break the Direct Consolidation into two loans: Subsidized and Unsubsidized.
You can choose the repayment plan for the new loan — 10-Year Standard is the default. The term on the Direct Consolidation Loan could be different depending on the amount of student debt the borrower has.
When It’s Useful
There are two common cases where a Direct Consolidation makes sense:
The borrower is going for PSLF and has old FFEL loans from undergraduate years.
The borrower wants to switch to a different income-driven plan.
We’ve seen borrowers consolidate just a single loan to help achieve one of these outcomes!
NOTE:#2 should absolutely never happen unless you’ve run the numbers on switching plans (including capitalizing interest).
For example, if you do a Direct Consolidation of FFEL loans which are midway through IBR 2009, you’ll be resetting the forgiveness clock on those loans. Instead of seeing forgiveness in 12 years, you’ll have to wait 20 years on PAYE.
This action can dramatically increase the total paid on the debt over time. Please proceed with caution!
Don’t do Direct Consolidation without running the numbers!
Simulating Direct Consolidation
At Payitoff, we recently found a way for you to run these numbers. If we detect an older loan that could benefit from Direct Consolidation, we’ll flag it in the opportunities section of the Overview:
Once you click on “Consolidate FFEL loans into Direct Loans”, you’ll see all the loans that are eligible:
After clicking “Consolidate”, these loans will enter the Standard 10-Year plan and simulate all the actions described above, including interest capitalization, the subsidization split, repayment schedule reset and more. You’ll be able to compare all the repayment options with the newly consolidated loan.
At the moment, we don’t have “undo” functionality for simulations. We recommend running a report without Direct Consolidation first then comparing that to the simulated version!
The Process
Once you’ve found whether it makes sense for the borrower to apply for a Federal Direct Consolidation Loan, there are a few steps:
Fill out the Federal Direct Consolidation Loan Application Form. Be very clear when filing out “Loans to Consolidate” and “Loans to not Consolidate” sections of the form.
Request a repayment plan to accompany the Direct Consolidation application. For income-driven options, the borrower needs to fill out an IDR Plan Request instead.
This can all happen online as well.
We hope this was a helpful primer to Federal Direct Loan Consolidation. If you have questions, feel free to shoot us an email! We’re here to help 😃
