A Comprehensive Guide to Student Loan Refinancing

May 16, 2017

With over $1.3 Trillion in student loan debt outstanding, and interest rates at or near all-time lows, there is a booming business in student loan refinancing. Several private lenders have emerged who specialize in refinancing these loans, and you can see their television ads almost daily. But while student loan refinancing might be a great way to save money and/or make your monthly payments more manageable, there are risks involved. If you are considering refinancing, here’s a review of the pros and cons, the risks involved, and a checklist to see if refinancing is the best option for you.

Pros

The potential benefits of refinancing include:

  • Saving money by getting a lower interest rate.
  • Restructuring the loan to be able to pay it off faster, or extend the maturity to lower your monthly payments.
  • Flexibility on terms (for example: changing from a fixed to variable rate).
  • Releasing co-signers (often your parents).
  • Consolidating multiple loans into one makes it easier and more convenient to keep track of your payments.

Cons

The downsides or potential risks of refinancing include:

  • Losing the benefits associated with federal student loans, including income-based or income-driven repayment plans, loan forbearance, forgiveness or cancellation programs.
  • Potentially paying more money over the life of the loan (if you extend maturity).
  • Loss of the grace period to delay payment you may have with your existing loan.
  • Switching from a fixed to a floating rate loan, which can lead to higher payments if interest rates rise.

So, how do you know if you are a good candidate for refinancing? Here are some basic questions to ask.

Is your interest rate relatively high (over 6%)? If yes, then refinancing may save you money.

Are your loans federal student loans or private loans? If they are all or mostly private, then refinancing to a new private loan would not mean giving up the benefits and options associated with federal loans. With federal loans, the primary benefit is that you are likely eligible for at least one of four income driven repayment plans. Such plans limit your required monthly payment to only 10% of your discretionary income. Under such plans as PAYE (Pay As You Earn) or REPAYE (Revised Pay As You Earn), a recent grad with $30,000 in student loans who is earning $25,000 a year would see her initial monthly payments reduced from $333 a month to only $60 a month!   The downside is that the loan is extended from 10 to 20 years.

As you can see, the option of converting to an income-based plan can be quite valuable for people with low incomes or whose earnings are unstable. If you are making under $50,000 a year or do primarily freelance/contracting work where your income often fluctuates, you should never give up the income-based repayment option that your federal loans provide.

In addition, with federal loans it’s possible to be granted forebearance, or a suspension of payment obligations, for reasons of personal hardship due to financial difficulties, medical expenses, or changes in employment. Private lenders may not be so flexible in helping you avoid a default.

Do you have an excellent credit score and a high salary? Private lenders have tightened their underwriting criteria. Only borrowers with very good credit (scores above 740) and higher income ($150K and above) will get the lowest rates and best repayment terms. Refinancing may not save you money if your credit is less than stellar. And if you apply and get declined this negative response turns up in your credit history.

Do you have a steady job and feel confident that your future income will remain stable and/or increase? If so, then reducing your current monthly payments by extending the maturity of the loan could be a good option.

In general, if your loans are mostly or all federal loans, if you are currently unemployed or your income is relatively unstable, and if your current interest rates are not too high, then the potential benefits of refinancing are likely outweighed by losing the flexibility and options that federal loans provide, especially income-based repayment plans. If your loans are all or mostly private loans carrying high interest rates, then you should consider refinancing. Finally, if you have very strong credit, a relatively high amount of income, and a strong likelihood of maintaining or growing that income over time, then refinancing could be a great way for you to save money.