While student loan refinancing can be a great way to save money on interest, it does come with some drawbacks, so it’s worth thinking about your current and future finances, as well as whether you’d like to take advantage of federal loan protections.
This article will explain what refinancing actually entails, help you figure out whether refinancing is right for you, and outline some of the risks to be aware of before you apply.
What exactly is student loan refinancing?
Student loan refinancing is when a lender pays off your student loans, and offers you a new loan, potentially at a lower interest rate. Refinancing is offered by private lenders, who often choose to offer lower rates to financially responsible (and hence less risky) borrowers, based on the borrower’s income, credit history, and other factors.
Can you refinance private student loans?
Most student loans held by U.S. citizens or permanent residents, including both private and federal loans, are eligible to be refinanced, with some exceptions. Some lenders require the loans to be for an education from a Title IV accredited school, while others will refinance loans from any U.S. university.
In addition, while most lenders require borrowers to have graduated or to be close to graduation, some do offer refinancing for any educational debt that meets other eligibility requirements—even if the borrower hasn’t and does not plan to finish a degree.
It’s important to keep in mind that if you refinance your federal student loans with a private lender, you may lose certain benefits that come only with federal loans. For example, federal student loans offer borrowers benefits like federal repayment programs like Revised Pay As You Earn (REPAYE) when repaying their debt — if you refinance your federal loans with a private lender, you may no longer be eligible for these programs.
Is refinancing the right choice for me?
It’s a good idea to consider refinancing if you’re looking to lower your interest rate, or pay off your loans faster. Refinancing can help you get a lower interest rate on your loan — when you lower your interest rate, more of your money can be used to reduce your principal debt, instead of just paying off interest
Refinancing may also be a good option if you’d like to release a cosigner from your original loan, as you can be the primary and only borrower on a new loan as long as your application—without a cosigner—is approved by the lender.
While there are certainly many perks to refinancing, you will forego certain borrower benefits that come with your federal loans. Read on to learn more about the implications of refinancing your loans with a private lender, and see if refinancing can benefit you.
First things first: you may not be approved
Before we get into what happens once you refinance, it’s worth noting that not everyone is approved for refinancing. Not only is this disappointing, it can also ding your credit score, as lenders conduct a hard credit pull in order to evaluate refinancing applicants.
If you’re working on building your credit, it’s worth going through a rate check (like Credible’s prequalification tool), which can give you a sense of whether you’ll be approved without conducting a hard credit check —and, if so, offer more insight into the rates you might receive.
Even if you are approved, keep in mind that the lowest interest rates are generally reserved for high-income applicants with excellent credit, so the starting rates advertised may be much lower than what you’re actually offered.
You’ll lose federal repayment options and certain government protections
When you refinance with a private lender, you’ll lose access to a number of federal programs that can help if you’re struggling to make loan payments, including income-driven repayment, deferment, and forbearance. You’ll also forego the option to participate in loan forgiveness programs.
Some private lenders do offer deferment and/or forbearance, but they’re not legally required to, so if you’re worried about maintaining these options after refinancing, be sure to research the options available from each lender. If you’re planning to take advantage of loan forgiveness (such as for teaching or public service), you may want to reconsider refinancing your loans, as you’ll lose the option to qualify for federal loan forgiveness programs if you do.
The loss of income-driven repayment, deferment, and forbearance options could be a concern if you’re unsure about your future employment and/or financial situation. These government protections can help you avoid loan default in the case of an unexpected drop in income or large expense, but private lenders may not be so forgiving.
Those who have a cushion, or emergency fund, on the other hand, may be more willing to relinquish these benefits in exchange for a lower interest rate.
You could be missing out on new government programs
With America’s student loan debt inching towards a total of $1.5 trillion, there’s no lack of discussion about what should be done and new ideas for policies that might help U.S. graduates better manage their loan debt. While it’s hard to know what might come in the next few years, refinancing now will mean foregoing the right to take advantage of future federal loan programs that don’t apply to private loans.
Variable interest rates introduce more risk into the equation
All federal loans issued after July 1, 2006, hold fixed interest rates. Many private lenders offer both fixed and variable interest rates, and variable interest rates are often initially lower, making them a compelling option for those with the primary goal of paying less interest.
But variable rates come with some additional risk, as they change when the reference rate they are pegged to goes up or down. If your monthly budget can accommodate an increase in your student loan payment, you may not mind taking the chance of rising rates—but those without as much flexibility are likely better off with a fixed interest rate.
Lower monthly payments could cost you
It can be tempting to opt for the lowest monthly payment when you refinance, but this will mean choosing a longer loan term—and the longer it takes to pay off your loans, the more interest you’ll pay. This is can be an even bigger issue when you stretch out your payments over a longer period of time without an interest rate reduction in a federal repayment program.
If you’re choosing lower payments for convenience, rather than need, do the math to calculate how much you could save in interest by making a higher monthly payment, and consider whether it’s really worth those extra savings in the short-term.
When the benefits outweigh the risks of student loan refinancing
If you’ve considered all of the above potential drawbacks to refinancing and still think it’s a good option for you (which many people do!), the next step is to decide which lender will be the right fit.
While you can apply to lenders individually, Credible’s platform offers the opportunity to apply with seven different lenders at once, not to mention seeing pre-approved rates before going ahead with a formal application and hard credit pull. You can learn more about the best student loan refinancing companies here.
Before applying, take stock of what’s most important to you when you refinance (such as interest rate, cosigner release, or repayment flexibility), then use those criteria to evaluate the offers you’re given—this will make choosing the right lender easy, so you can take advantage of the benefits of refinancing as soon as possible.