Loan refinancing can sound like an attractive option for those struggling to repay their existing student loans, but the pros and cons of the decision must be weighed before moving forward.
You may receive a lower interest rate when you refinance your loan, but you might also give up certain rights that can make repaying your new loan a challenge. Know your options before signing up for a refinance loan.
The Basics
Here are the basics you need to know about how student loan refinancing works:
What is loan refinancing?
When you refinance a loan, you are replacing an existing loan with a new loan. The new loan only pays off your current debt, it does not wipe it from your record.
The primary reason individuals and companies refinance their loans is to improve their loan terms, be it interest rates or loan lengths.
While both federal and private student loans can be refinanced, there is no federal refinancing program. You will need to go to a private lender to refinance an existing federal student loan.
Can You Refinance?
In order to refinance your loans, whether they’re private or federal, you need to show these points:
- You have a good credit rating, at least 700 for most lending institutions
- You have a steady job; generally, one that you have held for at least six months
- Your job provides an adequate discretionary income to make the monthly payments
While federal loans are granted equally according to a standard formula, that’s not the case for refinancing. Those with the best credit and highest income get the best terms.
Refinancing a Private Student Loan
If you have a private loan as opposed to direct federal student assistance, you likely have a variable interest rate. If you set it up when you were right out of high school, you probably didn’t have much credit history, so your rate may be high.
Once you graduate and find a steady job, your credit usually improves, so you can qualify for a better interest rate if you refinance. Here are a few things to keep in mind.
- Not all banks and financial institutions offer this type of refinancing, so you may have to do some digging to find a lender who will work with you.
- Pay attention to the Annual Percentage Rate (APR) on your loan. Even if you get a lower monthly payment, the interest rate can still be high if the repayment schedule extends over a longer period. That means you’ll pay more over the life of the loan.
- Ask questions about any benefits you might lose if you refinance. For example, military service members on active duty get certain rate benefits that they may give up. Don’t rely solely on the potential new lender for this information. Do your own review of your current loan carefully to see if there are perks that you’ll lose in refinancing.
- Consider your tax situation. You can take a tax deduction for student loan interest you pay, but some refinanced loans don’t qualify. Figure that into the calculations and make sure refinancing makes sense.
Refinancing a Federal Student Loan
Understand that there is no way to refinance federal student assistance into another federal loan. You can, however, refinance federal debt into a private loan. Here are some things to consider.
- The interest rate may not be lower. During periods of historically low rates, Congress doesn’t usually change the interest on federal student loans, so you may already have the lowest possible rate with your federal loan. A private lender may not offer you anything better when you inquire about refinancing.
- Pay attention to whether the new loan has a fixed or variable rate. Most federal loans have a fixed rate, which means that your payment won’t go up, even if interest rates increase. If your new loan has a variable rate, you must prepare for that possibility for as long as you have an outstanding balance.
- As with refinancing a private loan with another private institution, you may give up benefits when you refinance a federal loan into a private one. For example, federal student assistance has options, like income-based repayment (IBR), for borrowers who have difficulty making their regular monthly payments. Some, but not all private lenders offer flexible payment arrangements, so ask those questions upfront.
- Some fields involving public service, like teaching, medicine, or social work, offer loan forgiveness if you agree to work in an area of great need. You lose access to these programs if you refinance into a private loan.
Refinancing versus Consolidation
Though the terms are often used interchangeably, they are not the same. Consolidation refers to combining multiple loans into one, normally with no change in interest rate. Private loans are not eligible for this process. Refinancing involves moving an outstanding balance to another lender, usually for a lower interest rate.
As with every financial decision you make, refinancing your student loans is something you should research carefully. Every type of loan, every lender, and every individual’s situation is different. But if you ask good questions and consider all the options carefully, you may be able to save yourself thousands of dollars over time.
Advantages, Disadvantages & Alternatives
Read on to see if refinancing is worth it for you.
Advantages of refinancing a student loan
The primary advantage of refinancing your student loan is getting a lower interest rate. The less interest you accrue over the length of your loan, the less money you end up paying.
Additionally, the lower interest rate could mean you end up with a lower monthly payment, making your repayment less burdensome.
Individuals who took out private student loans with higher interest rates may be good candidates to refinance their loans. If you’ve improved your credit profile since college, you will likely be eligible for much lower interest rates when you refinance.
Consolidation
If you’ve taken out both federal and private student loans, and you’re looking to consolidate into one loan repayment, you may be able to do that through refinancing.
Removing a cosigner
If a family member cosigned a private student loan, you may be able to remove them from your loan when you refinance. Removing the cosigner from your loan protects them if you fall behind and miss loan payments.
Disadvantages of refinancing a student loan
When you refinance a federal student loan, you are essentially converting your federal loan into a private loan, and you will no longer be able to take advantage of federal programs. In particular, you will miss out on these two programs:
Income-driven repayment plans – With these plans, you pay a fixed percentage of what you earn during the course of your loan. Your monthly loan repayment goes up or down as your income increases or decreases. You don’t have to stress about meeting a fixed monthly payment if you aren’t making a lot of money.
Loan forgiveness
The government offers two loan forgiveness programs, the Public Service Loan Forgiveness Program, and the Teacher Loan Forgiveness program. Qualifying individuals working in public service or as teachers are allowed to wipe out a portion of their loan debt by meeting certain service requirements.
Tax consequences
Individuals paying off student loans are eligible for up to $2,500 in student loan interest tax deduction. Depending on your new loan, you may no longer be eligible for the deduction.
Alternatives to loan refinancing
If you’re considering refinancing a federal student loan, you may want to instead look into other federal programs first.
The Income-Driven Repayment program allows students to pay a fixed percentage of their monthly income, meaning they don’t have to panic if their income drops for any reason.
If you have multiple federal loans through multiple loan servicers, you can consolidate your loans into a Direct Consolidation Loan. The consolidated loan can make it easier to manage your repayments, as well as reduce your monthly payment by extending the loan.
