When to Consider Refinancing Your Student Loans
To refinance or not - that is the question. The arena of student loan refinancing can be a confusing one. Even if you can nab a lower interest rate by doing a refi, it still might not be your best move. There are a lot of important things to consider before you go through with a private refinance of your student loans.
First things first, when I say refinancing I mean taking your federal student loans (or your existing private student loans) and replacing them with a new private loan in order to reduce your monthly payments, lower your interest rate, or change your loan terms. This is different than a consolidation within the federal system.
A Direct Consolidation Loan allows you to consolidate (combine) multiple federal education loans into one federal loan. We’ll cover that next month.
When you already have private student loans, refinancing can be a great way to reduce your overall cost over time if you can obtain a lower interest rate. If you have federal student loans and you are wondering if refinancing into a private loan makes sense for you, read on.
A Few Rules of Thumb:
If your federal student loan debt balance is lower than your annual income: I would prioritize paying your loans down quickly to minimize your cost over time. A refinance can be a great way to achieve this.
If your balance is +/- $10k of your annual income with no major pay-raises in the foreseeable future: I would strongly suggest not refinancing to leverage your flexibility within the federal system until you get your balance lower.
If your balance is 1.25x your annual income: refinancing your federal debt to private is DEFINITELY not the best move for you.
Private student loan debt and federal student loan debt is not an apples-to-apples comparison. I always suggest looking beyond just the interest rate when considering private refinancing.
When Considering Refinancing Federal to Private:
Private loans have NO forgiveness opportunities. None. Zip. Nada. If you qualify for PSLF (Public Service Loan Forgiveness), teacher forgiveness, state forgiveness opportunities, or you may be better off going towards private sector forgiveness (reaching your IDR plan's max-repayment period), privatizing your federal loans is NOT the right move.
Private loans do NOT have income driven plans. Think long and hard about this. It’s important to know if you will be able to commit to that private monthly payment for the length of the term. There is a lot of benefit to having access to the federal income-driven repayment plans to keep your payments proportionate with your income year over year.
Fed loans have options to defer or go into forbearance if there is a financial hardship, disability, illness/health issues, etc. Private loans are more limited in those flexibilities or do not have them at all. Private debt is still due even if you die, standing first in line before any money goes to your family.
Interest is not charged the same while negative amortization is occurring (when your payment does not cover the interest charge per month): On the private side, any unpaid interest capitalizes (aka: compounds) which is the addition of unpaid interest to the principal balance of your loan. This means the debt balance can stay stagnant or actually grow. The math for compound interest is: principal x interest = your new balance, which interest is then charged off of, usually at a daily rate! On the flip side if federal loans have negative amortization, interest does NOT capitalize – it accrues in it’s own “bucket”. This means interest is only charged on the initial principal amount, not principal + accumulated interest. This is a HUGE deal for those with high debt-to-income ratios.
Relevant again in times of negative amortization: Federal student loans have interest subsidies or discounts/credits on how the interest is charged to you - this depends on your plan but generally unpaid interest can be waived or cut in half for time periods on certain loans.
Private student loan refinancing requires great credit. The average credit score needed to be even get approved for a refinance in 2018 was a FICO score of 764. If you don't have a score in that range, be prepared get declined altogether.
Going private, cannot be reversed.
With all that said, refinancing looks like the worst option in the world, right!? There are still compelling reasons for many folks to consider refinancing their student loan with a private lender.
Possible Benefits to Refinancing:
With a lower interest rate, you can:
Reduce your overall cost of the loan
Pay off your loans sooner
Reduce your required monthly payment
Often times choose your repayment terms
Combine multiple loans into one for simplicity
Change a variable interest rate to a fixed interest rate
If a refinance does make sense for you, and you have good credit, your next step will be to compare rates with a few refinancing companies. Start here:
Find out your pre-qualified rate(s) through a soft inquiry. Unlike hard inquiries, soft inquiries won’t affect your credit score since soft inquiries aren’t connected to a specific application for new credit. You will need to provide basic information on your financial situation, your existing loan balances, purpose for wanting to refinance, and information on your school, graduation date, and degree.
If your pre-qualified interest rate/range looks to be promising (lower than your current rate), go ahead and formally apply with that specific lender (hard inquiry). Make sure you read ALL THE FINE PRINT. Things to look for:
No refi fee
No prepayment penalty - allows you to accelerate payments if desired
Cosigner release clause - if you apply with a cosigner
Fixed interest rates - Variable rates can (and will) increase on you over time
If you are declined, apply with 1 or 2 other lenders in the same sitting. Credit Karma says: "FICO may record multiple inquiries for the same type of loan as a single inquiry as long as they’re made within a certain window (usually between 14-45 days). The VantageScore model gives you a rolling two-week window to shop for the best interest rates for certain loans." Either way, a hard inquiry could lower your scores by a few points, but in most cases it is unlikely to play a huge role in whether you’re approved for a new loan and the damage to your credit scores usually decreases or disappears even before the inquiry drops off your credit reports for good.
Student loan refinancing is not a slam dunk easy decision. There are many factors to consider and refinancing your student loans isn’t necessarily the best option for everyone. It’s important to make sure you consider the facts and considerations laid out above; a student loan refinance can be incredibly helpful in the right situation!
Meagan Landress, CSLP®
Certified Student Loan Professional™
Financial Coach Meagan