There are pros and cons to every strategy for repaying your student loans, Grownups. Planner Matt Becker shares many of the options and offers insight on choosing the right method for your needs.
If you’re dealing with student loans, chances are you’re feeling a little stressed.
Maybe you’re in your first job, income is scarce, and your student loans are eating up a significant portion of your budget.
Or maybe you’ve been dealing with them for years, you’re tired of making payments, and you want them gone so you can get on with your life.
Either way, paying them off as quickly as possible is bound to be appealing.
Refinancing can be a good way to make that happen. It’s also full of potential pitfalls and unintended consequences.
In this article, we’ll walk through the ins and outs of student loan refinancing so you know which questions to ask, what to watch out for, and how to make the right decision for your specific situation.
Understand the Difference Between Refinancing and Consolidating
A big potential pitfall is confusing refinancing with consolidating. The terms are often used interchangeably, but they have very different meanings when it comes to student loans.
Consolidation specifically refers to the Federal Direct Consolidation Loan program and only applies to federal student loans. The primary benefit of consolidating is often eligibility for income-driven repayment plans that you wouldn’t have otherwise qualified for.
Refinancing, however, refers to the process of taking out a new private loan to replace one or more existing federal and/or private student loans. In general, the primary benefit of refinancing is getting a lower interest rate.
Private lenders often use the term consolidation in their marketing materials when in fact they’re referring to refinancing, and you’ll want to watch out for that to ensure you aren’t misled.
Quick note: This article focuses specifically on opinions on the pros and cons of refinancing your student loans. Learn more about consolidation on Mom and Dad Money.
Refinancing Your Federal Student Loans: Pros and Cons
If you have good credit, it’s possible you could significantly lower your interest rate by refinancing your federal student loans.
But that doesn’t necessarily mean that it’s a good idea.
Federal student loans come with some protections, including income-driven repayment plans, the possibility of forgiveness, and deferment or even discharge if you run into financial or medical trouble.
Refinancing may mean giving up some or all of those protections, which means you’ll have less flexibility and/or forgiveness if your financial circumstances change. Even a better interest rate isn’t necessarily worth those concessions.
So, when should you consider refinancing your federal student loans? There’s no one right answer, but generally, it makes the most sense if all of the following are true:
- You have a high credit score and qualify for a significantly lower interest rate than your current loans.
- Your income is both stable and significantly larger than your student loan debt.
- You spend significantly less than you earn.
- You don’t have other large debts or anything else that adds risk to your financial life.
Even then, it’s worth proceeding with caution and making sure you fully understand the protections you’d be giving up. But in the right situations, refinancing your federal student loans could save you a lot of money.
Refinancing Your Private Student Loans: Pros and Cons
Things are a lot simpler when it comes to refinancing private student loans. In some cases, you may actually gain protections by refinancing, since some of the newer lenders have increased their standards when it comes to private loans.
For the most part, refinancing your private student loans will make sense under the following conditions:
- Your current loans have high interest rates.
- Your credit score has increased significantly since you took out your current loans.
The higher your current interest rates and the bigger your increase in credit score, the more likely it is you’ll qualify for a significantly lower interest rate, a lower monthly payment, and (hopefully) a lower total cost over time.
If you meet those criteria, consider the following before deciding to refinance:
- Length of the loan—A lower interest rate will almost certainly lead to a lower monthly payment. But if that payment is spread out over a longer period, it could still end up costing you more money.
- Fixed or variable rate—Is your interest rate fixed or can it increase over time? If it can increase, by how much and under what conditions?
- Cost to refinance—Are fees involved? The larger the fee and the smaller the loan, the more harmful it’s likely to be.
- Protections—What happens if your income decreases? What if you have a serious medical condition? Compare the protections your current loan offers to those of the new loan.
- Other terms and conditions—Are there prepayment penalties if you want to pay more than the minimum? What happens if you miss a payment? Check all the terms and conditions before signing anything.
If you want to look into your refinancing options, local credit unions are a good place to start, as they often have favorable rates. You can also look online at companies like CommonBond, DRB, and SoFi.
Proceed with Caution
While refinancing your student loans has the potential to save a lot of money, it’s a good idea to proceed with caution.
The good news is this business has improved in favor of borrowers over the past few years, making it easier to refinance your loans on favorable terms.
The bad news is these lenders are still in the business of making money, so you need to tread carefully and make sure you know exactly what you’re getting into.
Ask the right questions and gather the right information, and you can make the right decision for your specific situation.
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