Should I Refinance My Student Loans?

If you’ve never considered refinancing your student loans, that’s almost certainly not the fault of the financial services industry. Lending institutions seek borrowers with an aggressiveness that compares favorably with sharks smelling blood.

The big difference, of course, is – unlike the sharks – the lenders might actually be able to help you. Key word: might. Private refinancing could save you money. But refinancing federal student loans could cost you benefits that only they provide. There is no one-size-fits-all answer, so get ready to do some research and cost comparisons before going the re-fi route.

Yes, and lowering the interest rate and saving money should be the primary reason to consider it. Consider this scenario:

You have 10 years left to pay $40,000 remaining on your federal student loan at 8% interest. Currently, you’re paying $485.31 per month, which will add up to $18,237 interest over the life of the loan.

If you can refinance the same amount with a private lender at 5%, your monthly payment will be $424.26 per month, and the total interest payment will be $10,911 interest. You’ll save $61 per month, which will make life a bit more comfortable, but, more significant, you’ll save $7,326 in interest payments by the time you’re done.

Can Refinancing Help Me Pay Off My Debt Faster?

Another way to save money in the long run is to refinance to a lower rate but keep paying the same amount for month. You’ll pay off the loan faster and pay less total interest. In the above scenario, for example, paying $485.31 a month at 5% would cut the payoff time down to 8.5 years and only $9,105 would go toward interest.

Alternatively, even if you can’t find a lower rate, it’s also possible to lower monthly payments by refinancing for a longer repayment time. Beware – extending the repayment time to lower payments  means paying more in interest in the long run.

But it could also be a way to make ends meet.

Simplifying Your Life

If you have multiple student loans, refinancing can consolidate those loans into a single loan with a fixed-interest rate. That’s a common situation because providers often limit how much they would loan per year, so students may need more than one to cover their expenses, then get more loans in subsequent years. Again, a lower interest rate makes consolidation an even better reason.

Even if a significantly lower rate isn’t available, getting a fixed-rate loan to replace existing variable-rate loans is another potential benefit of refinancing. Variable-rate loans may start at a low percentage but rise later, and a fixed-rate refinancing can take some of the guesswork out of budgeting. Interest rates have been rising, and that trend is expected to continue. Locking in a rate could save you money.

What Are the Risks of Refinancing Student Loans?

One consideration is basic to most loans: Do you have a contingency plan if lose your job or otherwise can’t pay?

This is especially true of refinancing federal student loans, which provide benefits and protections that are not available from private lenders.

Can you refinance federal student loans? Absolutely! But before using private lenders to refinance, you need to determine how important the benefits attached to federal loans are to you and whether it’s worth giving those up.

Some federal student loans provide lower monthly payments to low-income students, which you can’t get from private lenders.

The federal government also offers the Federal Direct Consolidation Program, by which you can consolidate multiple federal student loans into one. The new rate is an average of your current rates. This probably won’t lower your payments, but consolidation simplifies your debt by giving you only one monthly payment. Consolidations also offer a longer time to repay, as much as 30 years, though – again! – that means paying more in interest on your loan.

Federal loans offer forgiveness for borrowers based on hardship or depending on their employment. Those in government jobs, military, teaching and some nonprofit work may be able to have large portions of their federal loans forgiven. No private lender offers that.

It doesn’t happen often, but the U.S. Department of Education may forgive loans if your school defrauded you or has closed.

There are other benefits and protections for federal student loans, but they all go away if you choose to refinance through a bank, credit union or online lender.

How to Qualify for a Refinance

Whether you qualify to refinance and the rate you get at least partly depends on your credit score. Some private lenders (especially online sites) have a minimum score to even qualify for a loan, and the higher the score, the better the rates are going to be. Credit scores rate how likely you are to repay the loan. Making your current debt payments on time and paying down your debts are excellent ways to boost your score. FICO credit scores about 700 are considered good; above 740 is considered excellent.

Lenders also look at your debt-to-income ratio – how much you make against how much you have to pay creditors per month. When debt payments make up 30% or more of your monthly income, lenders won’t give you their best rates. The best strategy in that situation is to pay down your debts and, if possible, increase your income.

It’s also a good idea to check your credit reports, which can be done for no charge every year at annualcreditreport.com. If there are inaccuracies, get them corrected before applying for a loan.

An alternative for those unable to qualify for refinancing is to find someone with better credit to cosign your loan. That’s often a family member, because that person becomes legally liable for the student loan if you fail to pay.

The cosigner isn’t the only one taking a risk. Check the contract carefully. If the cosigner dies or declares bankruptcy, the lender might be able to place the student loan in default, and you’ll owe the remaining balance immediately, even if you’ve kept up with your monthly payments. Again, check carefully.

So, shop around to get the best rate possible. Make sure you have weighed the repayment benefits offered on federal student loans and decided you won’t need them to pay off a refinance. This decision can either make it faster and less expensive for you to pay off a student loan … or, it can go the other way and put you in deeper hole of debt.