What’s the difference between consolidation and refinancing? Which options make sense for your student loans? The more you know, the more informed loan shopper you can be.
MarketWatch reports that 40 million Americans collectively owe more than $1 trillion in student loan debt, and lenders now see an opportunity. In addition to the financial institutions and student loan consolidation companies that have existed for decades, a new wave of alternative lenders like College Ave, CommonBond, Earnest, and SoFi have popped up to meet the student loan refinancing demand.
Like most financial advice, there isn’t a simple answer to whether borrowing to pay off lingering student loans will be to your advantage, but it’s worth exploring nonetheless. Here are some of the key factors to keep in mind if you’re considering refinancing student loans.
Should you Consolidate or Refinance?
Student loan consolidation and student loan refinancing are often used interchangeably. But based on your loans and objectives, it’s key to know how the terms differ.
Student loan consolidation lumps your student loans together into one loan. The interest rate is determined based on a weighted average of your current interest rates; consolidation allows you to make one monthly student loan payment, instead of several. If you have federal student loans, consolidating them probably won’t save you money (for the very reason that the interest rate is a weighted average). Consolidating private student loans may result in a lower interest rate, but that depends on variables like your credit score and history, your current loans, and the lender.
When you refinance student loans, you replace your existing loan (or loans) into an entirely new loan with new terms and interest rates. Refinancing should ideally result in a lower interest rate and more competitive terms than your current loans, but consider these important factors when evaluating your options:
- The outcome of your college education. Most lenders require that you have completed a degree obtained from a Title IV school in order to refinance student loans. Confirm whether your alma mater fits the bill at the FAFSA website.
- Your credit. Though many alternative student loan refinance lenders promise to consider more than your credit history in their loan decision, you’ll likely find more refinancing options with a credit score of 680 or higher, according to Jeffrey Trull at Student Loan Hero. That said, the experts at MyFico recommend you conduct your search for the most competitive loan within a 30-day time frame. Not all inquiries for a rate quote will require a hard pull of your credit report, but if some do, the inquiries aren’t likely to negatively impact your credit score if they take place within a short time frame.
- Your loan type(s). You can comingle federal student loans and private student loans into one refinanced student loan, but refinancing federal student loans is risky business if you meet any of the criteria that will allow you to pause, lower, or qualify for forgiveness of federal student loans. If you refinance federal student loans, you could lose those benefits entirely. While some alternative lenders offer the ability to pause payments in special circumstances, the terms of your employment may impact the degree of forgiveness they are willing to offer (if any).
- The interest rate. According to SoFi, its average refinance borrower in 2015 locked in a 68 percent for a loan with a 10-year term. If you opt for a variable interest rate loan, you may find an even lower interest rate. However, refinancing your student loans with a variable interest rate loan can be risky; if you know you can pay the loans off quickly (and in full) this may be a viable option for you.
- Your employment status. Your student loan refinancing options may not be based solely on credit, but most lenders require that you have income (and can prove the source and amount).
- The loan term. Betsy Mayotte of the nonprofit organization American Student Assistance (ASA) says you typically don’t want student loan payments to take up more than about 8 percent of your income. The term of your loan will have a bearing on what you must pay each month. If you have considerable student loan debt, your required monthly payment could be significant with a shorter-term loan. Consider how the monthly payments will fit into your budget, without sacrificing your ability to save for retirement, and establish an emergency fund to cover at least three to six months of your living expenses.
- The tax benefits. The experts at Student Loan Hero offer a free calculator to help you figure the tax value of any student loan interest you pay and may be able to claim as a tax deduction. Run the numbers to see whether it impacts the value of a potential student loan refinance.
There’s a lot to consider when deciding if refinancing student loans is a good option for you, but the more you know, the more informed loan shopper you can be.
You might also consider these resources to help resolve student loan debt:
- Student Loan Genius. Similar to a 401k match, this service allows employers to contribute directly to their employee’s student loan payments.
- American Student Assistance/Salt Money. The nonprofit offers a guide with more than 100 resources that can help you eliminate student loan debt.
- FinAid. This guide offers a free calculator to help you run the numbers and compare student loan refinance options.
Stephanie Taylor Christensen is a former financial services marketer
turned freelance writer who covers personal finance,
career, health, and small business news.
She is the owner of Om for Mom prenatal yoga in Columbus, Ohio.
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