With interest rates hovering near all-time lows, we see commercials and ads for home refinancing all the time. By choosing a new loan with a lower interest rate and better terms, the experts say, you can lock in a lower monthly mortgage payment, extend or reduce your loan’s term, and pay less in total interest.
While it isn’t advertised to the same degree, you can usually score a similar deal with your student loans. Through any number of highly reputable banks or lenders, you can consolidate existing student loan debt into a new loan with a more manageable payment, shorten your loan’s term, and save money all along.
As with anything else, there are advantages and disadvantages for doing so. Beyond the investment of your time, there are myriad financial implications to consider – along with some important benefits you lose if you refinance federal loans with a private lender.
While some borrowers are better off moving into a new loan product, others should stick with the loans they already have. At the end of the day, the benefits of refinancing or consolidating depend on a student’s existing loans and what their ideal student loan payment looks like.
How to Decide Whether to Refinance or Consolidate Your Student Loans
First things first: Before you decide whether refinancing or consolidating makes sense, you have to decide on a goal.
Where some people hope to save money on long-term interest, others hope to score a lower monthly payment that they can actually afford – even if that means extending their loan term over several more years. Still others hope to accomplish a little of both – refinancing into a loan with a lower interest rate and payment, but still have their loans paid off in a reasonable amount of time.
According to Nate Matherson from LendEDU, a marketplace for student loan refinancing and consolidation, the best candidates for refinancing are individuals who are paying a lot of money towards interest each month – and private student loan borrowers usually stand to save the most money.
“Some private loan borrowers are paying upwards of 10% in interest per year,” Matherson says. With certain types of refinancing, you can lower your annual interest rate to as low as 2%, especially if your credit has improved since you first took out the loans.
By securing a loan with a lower interest rate, he says, you can save money on interest every month and every year, plus potentially pay down your loans faster.
If your current monthly payment is unmanageable, refinancing over a longer term can also free up some breathing room in your monthly budget. “When you refinance, you can choose a new term length from five to 25 years,” says Matherson. “You can extend the repayment of your student loans and cut your monthly payment down.”
The risk here is extending your repayment so long that you’re actually pay more in interest, despite the lower interest rate. Still, some people choose this route because they’d rather have a payment they can live with for a longer time than struggle every month and risk defaulting on the loan.
It’s worth stating that you should only ever refinance or consolidate if it results in a better situation. Never refinance at more unfavorable rates, and never add a new loan on top of the old.
Some private lenders, like Discover Student Loans, may offer a refinance/consolidation mix. You’ll have the ability to combine private and federal loans, and you might be able to lower your monthly payments and interest rates.
One last reason it can make sense to refinance or consolidate your loans is if you need to simplify your life and your finances. If you’re making several student loan payments every month and have trouble keeping track of them all, refinancing and consolidating allows you to funnel all of your existing loans into one new loan with a new rate and payment.
While you may not save a lot of money if you don’t get a significantly lower interest rate, you can win the mental battle by reducing the number of payments you’re making down to one. For some people, having a single student loan payment to contend with makes it a lot easier to plan, create a budget, and ultimately pay off their student loan debt faster.
Refinancing and Consolidating Your Loans: Risks You Should Know About
While the financial rewards can be ample when you refinance high interest or unmanageable loans into a new product, there are risks to consider as well. Most of these risks come into play when you refinance or consolidate federal loans with a private lender.
Doing so means saying goodbye to all of the Department of Education benefits offered on federal loans, says Matherson. These benefits include all income-driven repayment plans and public service loan forgiveness, plus stopgap measures such as deferment and forbearance.
“If you are currently using, or plan to use, any of your federal student loan benefits you should think long and hard before refinancing,” says Matherson. Because once you refinance, these options will no longer be on the table.
The other big risk that comes with refinancing is one we already talked about – extending your repayment timeline so much that you actually pay a lot more interest on your student loans over time. Before you refinance your loans to get a new monthly payment, make sure to look at the total amount you’ll pay over time and compare it to your total loan costs now. If it’s considerably more, you might want to rethink refinancing and consider alternative strategies to lower your monthly payment instead.
Got Federal Loans? Consider Income-Based Repayment Plans Instead
Speaking of alternative repayment strategies, income-based plans created by the federal government offer relief for students with low incomes but plenty of federal student loan debt. Income-driven repayment plans to consider include:
- Income-Based Repayment Plan (IBR)
- Revised Pay As You Earn Plan (REPAYE)
- Pay As You Earn Plan (PAYE)
- Income-Contingent Repayment Plan (ICR)
Since these repayment plans are based on your income and only available to individuals with eligible federal student loans, not everyone will qualify. Those who do, however, can get a lower monthly payment – one capped at a certain percentage of their discretionary income – for a period of 20-25 years. After that, the entire balance of their loans is forgiven – as in, wiped away to a clean slate.
Another option to consider is Public Service Loan Forgiveness, or PSLF. With PSLF, you can have all of your loans forgiven if you commit to a career in a qualified public service position and make 120 consecutive payments (10 years’ worth) on your student loans. While public service isn’t right for everyone, it can be a natural fit for people who work in health care, education, the legal justice system, social work, or dozens of other fields geared to helping others.
Just as you can refinance your home, you can refinance or consolidate your student debt into a new loan with better terms. The key to deciding whether refinancing makes sense for you is to take a close look at your current roster of loans and compare that to the new loans currently available. Our Student Loan Consolidation Guide can help in that respect, and also direct you toward additional resources that can help you decide.
Before you refinance your student loans, make sure you’re truly getting a better deal. To come out ahead, your new loan will need to offer a monthly payment you can actually live with, provide some interest savings over the long term, or simply make your life easier.
Also remember that the grass isn’t always greener. While the right loan can offer some relief, the wrong loan can add to your struggle. Run the numbers and consider them closely, because numbers don’t lie. Any decision you make should be backed up by facts, not just wishful thinking.
Have you ever considered refinancing your student loans? How much do you owe, and when will it be paid off?