Brief History of Loan Consolidation

Historically, loan consolidation was used as a method to help borrowers who were in danger of defaulting on their loans. The new consolidation loan would pay off the delinquent loans and borrowers had a new start and a chance to clean up their credit history.

One attractive feature of federal loan consolidation is that a consolidation loan may replace a loan with a variable interest rate with one that has a fixed interest rate. When interest rates began to fall to all-time lows beginning in 2001, federal loan consolidation became very popular, as borrowers refinanced their loans to lock in rates as low as 2.875%. Loan consolidation had become such big business that several companies were created for the sole purpose of consolidating education loans.

On February 8, 2006, President Bush signed the Higher Education Reconciliation Act of 2005 (HERA) which made some significant changes to federal consolidation loans. The most significant change is the repeal of the Single Holder rule. This rule required borrowers who had borrowed all of their federal Stafford or PLUS loans from one lender to consolidate with only that lender. Borrowers may now consolidate with any consolidation loan lender in the country: this means that borrowers have a choice and are not restricted to where they can refinance their loans.

The HERA also eliminated the ability of Direct student loan borrowers to consolidate while enrolled in school. Direct loan borrowers must now wait until the loan is in grace, repayment, or in deferment (other than in-school status) to consolidate. This also eliminates the new grace that was issued to those loans that were consolidated during an in-school status.

The HERA eliminates the ability of a married couple to consolidate their eligible loans in a joint federal consolidation loan. This is a good change, as the joint consolidation loan was never a good idea.

The HERA also replaced variable interest rates on non-consolidated Stafford, Direct, and PLUS loans with a fixed rate for loans first disbursed on or after July 1, 2006.

Now that federal education loans are fixed, loan consolidation may lose some of its appeal. But there are still reasons to consider loan consolidation.

Effective October 1, 2007, the College Cost Reduction Act (H.R. 2669) has caused additional changes in the federal loan consolidation programs. This act has reduced the government's subsidy to consolidation loan lenders, thus requiring these lenders to reduce or eliminate borrower benefits on their consolidation loans. Several lenders have left the consolidation business because of this change. This change will affect many students and parents looking to reduce their overall loan repayment costs.

Private loan consolidation is becoming more popular. Borrowers of private alternative loans are now able to consolidate their loans. The interest rate on the consolidation loan remains variable, but there may be advantages for a borrower to consider private loan consolidation.