How to Decide If You Should Refinance Your Student Loans
Refinancing your student loans seems to be the thing to do lately. In the past year, I've had several friends tell me how they were able to lower their interest rate significantly by refinancing their loans with private loan providers. I decided to take a closer look at what all the student loan refinancing hype was all about and if it was really worth it.
Types of Student Loans
There are two types of student loans: federal and private. The Federal Direct Loan Program is administered by the Department of Education and is typically your first source of funding as a student. The main loan types are Subsidized and Unsubsidized Stafford loans, PLUS loans and Consolidation loans. The interest rate is fixed for the life of the loan and the same across borrowers, no matter what type of credit you have.
If your borrowing costs exceed the limits of federal student loans, then you may choose to borrow from a private student loan program to close the funding gap. Private loans are available with fixed or variable interest rates -- the rate will depend on your credit history.
What Is Refinancing?
When you refinance your student loan, you're essentially getting a new loan. The new provider pays off your existing loan provider and gives you a nice, fresh loan with new terms and hopefully a lower interest rate.
Federal loans can be refinanced through the federal student loan program or through a private loan provider, while private student loans can only be refinanced through a private loan provider.
If you refinance your federal student loans through the Federal Direct Loan Program, then your new interest rate will be based on the weighted average interest rate of your existing loan(s). This helps you simplify your bill paying but may not turn into actual cost savings.
When you refinance your federal and private loans through a private loan program, your interest rate will be based on your creditworthiness, which could help you get a much lower interest rate. Some factors private loan providers may take into account when determining your interest rate include credit score, income, employment history, and debt-to-income-ratio.
Benefits of Refinancing
There are a couple of benefits of refinancing your existing loan(s) through private loan providers:
- Lower interest rate: The main benefit is being able to lock in a lower interest rate for the life of your loan. Borrowers with strong financial profiles -- including good credit scores, high income and stable employment -- have the highest likelihood of receiving lower interest rates. One of my friends had a Stafford loan with an interest rate of 6.80 percent. After refinancing with SoFi, she lowered her rate to 2.91 percent. Her new loan has a variable rate, so the rate could increase, but it's been steady for the past year.
- Lower monthly payment: Another potential benefit is a lower monthly payment. Aside from being realized through a lower interest rate, this could also be achieved by extending the term of your loan. Although your monthly payments will be lower, since you extended the term of your loan, you could end up paying higher interest payments overall.
- Borrower benefits: Some loan providers may also offer borrower benefits, which give you a discount on your interest rate for setting up direct debit on your loan or making a certain amount of on-time payments. My friend mentioned above received a 0.25 percent discount for signing up for direct debit (i.e., autopay).
- Simplified billing: Refinancing could help you consolidate many loans from different providers into a single loan with one provider, thus, reducing the number of bills you receive or need to track.
While scoring a lower interest rate could help your immediate financial situation, there are other factors to take into account when determining whether refinancing is right for you, especially if you are considering refinancing federal student loans through a private student loan program.
Federal student loans come with a couple of benefits that could be lost if you refinance your loans through a private loan provider:
- Income-based repayment: Some federal student loans offer borrowers with lower incomes an income-based repayment option. If this option is important to you, you should consider refinancing through the federal student loan program rather than with a private loan provider.
- Loan forgiveness: Borrowers in certain types of public service jobs, such as government jobs, teaching, and other nonprofit careers may be eligible to have portions of their federal loans forgiven. Be sure to check your eligibility for loan forgiveness before refinancing.
- Federal student loan payments: Some employers make payments on federal student loans as an employee benefit. If your company offers such a benefit, make sure to check if your employer would still make payments to your new private student loan after you refinance.
In the end, refinancing your existing student loans through a private loan provider could help you significantly lower your interest rate and monthly payment while simplifying your billing. However, in the case of refinancing federal student loans through a private loan program, it's important to weigh the existing benefits you may have on your existing federal loans before refinancing using a private loan provider.
You can find more information about student loan refinancing by visiting some of the top private loan provider websites, such as SoFi, CommonBond or Citizens Bank.
Roger Ma is a digital media professional, personal finance expert, and licensed real estate salesperson. He is the founder of lifelaidout, a personal finance blog that helps others identify value and save time, money, and energy in their everyday lives.