David K. Randall, 04.15.09, 06:00 PM EDT
Student-loan consolidation has its benefits, but it's not for everyone.

It seemed like Monopoly money to her. Emily, a New York University senior who prefers not to use her last name, took on thousands of dollars of student-loan debt without giving it much thought--until now. Just weeks from graduation, she is applying for paralegal jobs in a tough market and suddenly coming face-to-face with the fact that in six months, she'll have to start making monthly payments of around $250 on her $20,000 debt.
"All I had to do was sign on to the Sallie Mae Web site, check off a few boxes and wait for the money to be disbursed," she says. "The thought of repaying it never really hits you until graduation is near."
If only the task of repaying student loans was as easy as taking them out. Instead, it's a complex process with which millions of college grads must grapple. Two out of every three undergraduates walk off the graduation stage with some form of student debt, according to a 2008 College Board study. The average: $22,700 per graduate--and that doesn't count the student-loan debt incurred by the half of entering college students who never earn a degree.
With three federal loans and seven private ones, Emily is in a situation familiar to college seniors and recent graduates across the nation. Like her, many consider consolidating their loans as a way to lower their monthly payments and simplify their finances. The theory is that, either by stretching out repayment of the loans or refinancing them at lower interest rates, the borrower can reduce monthly payments. Unfortunately, it's not a strategy that works for everyone.
One problem for people like Emily is that federal loans cannot be consolidated with private ones. Another is that beginning in July 2006, all federal student loans began carrying fixed interest rates. Before then, federal loans were issued with variable rates; by consolidating them, borrowers could often lock in a rate that was lower than what they were paying on each loan separately.
Now, "there is no financial benefit to consolidating federal loans, other than having a single monthly payment and access to alternative repayment plans," says Mark Kantrowitz, publisher of FinAid, a Web site that tracks the college financial aid industry.
If you can afford to make the payments on your loans, Kantrowitz says, consolidation isn't going to help you. If, on the other hand, you are having trouble making your monthly payments or think that you will in the future, consolidation can present several alternatives.
Remember, though, that while practically all repayment plans lower the monthly payments, they also add on several thousand dollars in interest costs by stretching out the life of the loan. If, for example, you stretch out a standard 10-year student loan to 20 years, you can cut monthly payments by 34%, but you will end up paying double the amount of interest over that time, Kantrowitz says.
If some or all of your loans were written before July 2006--say, in your freshman year of college if you are graduating this year--wait until after July 1, 2009 to consolidate, Kantrowitz suggests. He predicts the interest rate will tumble to a historic low of 2.6% from its current 4.2%. The problem with acting too quickly? Borrowers who have already consolidated won't be permitted to do so again at the new rate.
Starting this July, borrowers who have federal student loans can opt for a new income-based repayment plan. This may be a smart option for those entering fields with relatively low salaries, like public service. Under the plan, which is open to anyone with federal loans, the monthly payments are capped at a certain percentage of the borrower's income.

The rate is defined as the difference between the person's adjusted gross income (the amount on which you are subject to pay federal taxes) and 150% of the federal poverty level (which comes out to $16,245 for an unmarried person with no children, based on current rates.)
For an unmarried individual with no children and an adjusted gross income of $40,000, monthly payments would be capped at $365. An increase in salary would mean an increase in the monthly payment. If the full amount borrowed is still not paid off after 25 years of these payments, the remaining balance is forgiven.
Students who have already started repaying loans can opt for the income-based repayment plan, but there is an important caveat: Doing so will restart the clock and give your loan a new term of 25 additional years.
Emily, the NYU senior, like many students, had to turn to private loans to cover what federal programs would not. Private loans, unlike federal ones, carry variable interest rates. Consolidating them may save students money.
If, when the borrower took out the loan, he had a limited credit history, as most students do, three or four years of making regular payments on a credit card or an impressive employment history can improve a credit score by 100 points or more. That, in turn, can persuade a lender to reduce the interested charged as a result of a loan consolidation.
"Borrowers can get a lower rate now, and their rate may not jump as high in the future," Kantrowitz says.
Another potential benefit of consolidating your private loan is the removal of a co-signer, which can save a parent or relative from a potential liability. This is possible after 24 to 48 months of making regular payments.
If you would like to consolidate your private student loans, you should turn to either Chase, NextStudent, Student Loan Network or Wells Fargo ( WFC - news - people ), Kantrowitz suggests. All offer slightly differing terms, and all have caps on the amount of total debt you can consolidate.
Important questions to ask a consolidator are whether it charges origination fees, if there are prepayment penalties, what the maximum interest rate is and what the life of the loan will be. Read the terms carefully, and if possible, have a friend or relative do the same. If you don't understand something, ask the lender until you get a straight answer. After all, you're entering into a contract that can last as long as 30 years.
Steer clear of any lender that charges a prepayment fee. You'll want the option to pay off the loan early without being penalized for it.
Comments or questions? E-mail drandall@forbes.com.