When college students first take out their student loans, they often have little to no credit and very little income to speak of. In the banking world, these two factors increase the risk that a borrower will default on their loan and the interest rates that students are offered will reflect this risk.
But after graduating, getting a job, and building credit, many student loan borrowers could qualify for better interest rates.
This is where student loan refinancing comes into play. There are plenty of lenders out there that specialize in student loan refinancing. Perhaps you’ve been contacted by one or have seen of their advertisements and it’s gotten you thinking about whether or not refinancing your student loans would be a smart move.
But before you make any decision about refinancing your student loans there are 6 critical questions that you need to ask yourself.
1. How much money would you save over the life of the loan?
While you may think that you could save a lot of money by refinancing your student loans, when you actually do the math, it may not be as much as you think.
The Federal Funds Rate has been near historical lows for the better part of a decade, so the interest rate on both federal and private student loans have followed suit.
This means if you graduated fairly recently, your original loan may have already been at a decent rate.
Even with dramatically better credit today than you had during your college years, you may find that you’re not able to change your student loan interest rate by even a full percentage point.
That’s not to say that refinancing for even a .25% lower interest rate wouldn’t be a good idea. It could still save you a good chunk of change, especially if you have large student loan balances.
- But we’re definitely not talking about a situation here where the average interest rate has fallen off a cliff in the last few years from previous highs.
- Rather, we’ve been at, or near, the interest rate basement for a quite a while. If anything, rates will most likely only be going the opposite direction for the foreseeable future.
Additionally, as we will cover below, if you decide to refinance your federal student loans by moving them to a private lender, you will lose all of the payment and forgiveness options that federal loans afford.
If you are going to lose those benefits, you want to make sure that it’s in order to save a meaningful amount of money.
It’s for all these reasons that I always recommend that before you contact any refinance banks you first use a student loan refinance calculator to find out exactly how much you would be able to save over the life of the loan.
If you end up being blown away by the amount you could save, that’s great! You can now proceed with confidence, knowing exactly why it’s the right financial move for you.
2. Would your new loan have a fixed or variable interest rate?
If you are someone who currently has federal student loans, the interest rate on your loans are fixed. Your rates are guaranteed to remain the same for the life of the loan.
Private lenders, on the other hand, usually offer both fixed and variable interest rate loans.
- The variable interest rate loans are often a full percentage point lower than the fixed interest rate.
- These are also the rates that tend to show up on advertisements that you’ll see online.
Before you get too excited about an interest rate that you’ve seen advertised somewhere, you need to find out if that rate is for a fixed or variable loan.
While variable loans could theoretically save you a lot of money in interest, you are taking the risk that savings you accrue near the beginning of the loan repayment schedule could we wiped about later on if interest rates rise too high.
And as we discussed above, interest rate increases are likely over the next few years.
Because of this, my recommendation would be to only take out a variable rate loan if you truly believe that you will be able to pay it off in the next 3 years.
Other than that, I would stick to fixed rates loans. The security of a locked-in rate that they offer is just too valuable, despite the fact that you’ll be charged a slightly higher interest rate up front.
3. Are you ok with losing out on all federal student loan benefits?
If you currently have federal student loans, there are many benefits that you can take advantage of. A few of these benefits include:
- Delayed interest accrual until after graduation for subsidized loans.
- Income-driven repayment plans.
- Long repayment timetables
- The possibility of loan forgiveness
- The possibility of loan forbearance during times of hardship or loan deferment if you go back to school
Many don’t realize that once you refinance your federal loans into a private loan you lose all of those benefits.
Now, much has been said about the extra money that will end up paying in interest by continuing to delay payment on your student loans, and all of those warnings are valid.
- Do I think that you should pay off your loans as fast you can? Yes.
- Do I think that it would be great if you didn’t need to use an income-driven repayment plan or needed to ask for student loan forgiveness? Absolutely!
But everyone’s situation is different.
- You could be someone who is actually very close to earning Public Service Loan Forgiveness.
- Or you could be someone who really needs an income-based plan for the time being in order to provide for your family.
The point is that it would be arrogant and irresponsible of me to just blindly instruct you to forfeit your student loan benefits without knowing your personal situation.
Only you can decide if losing federal student loan benefits is a refinancing deal-breaker…or simply no big deal.
4. Have you achieved career stability?
Your career stability, especially over the next few years, should play a major role in whether or not you decide to refinance your student loans. To explain why we’ll look at two different scenarios:
Scenario #1: Career stability and income growth expected
If you are someone with a steady job who expects your income to grow over the next few years, then refinancing your student loans today could really be a smart move.
Why? Because as your income goes up, the federal income-based repayment plans require you to pay more.
If your income steadily rises, you may be required to start making some pretty large monthly payments in just a few years.
At that point, maybe 2 or 3 years from now, you may consider refinancing your student loans.
But who knows what the average interest rate will be at that time?
By that time, it may have risen to the point that it would be no longer worth it to refinance.
If you can reasonably expect your income to grow over the next few years, then acting sooner rather than later to refinance could be a smart move.
Scenario #2: Career transition and income instability expected
Ok now let’s flip the script and pretend that you are someone with a steady job, getting paid a great salary, but are considering a career move in the near future.
In this case, I would strongly discourage you from refinancing your federal student loans.
Remember, with your federal loans, your monthly payments would go back down in the event that your income dropped.
- But this benefit would not be available to you with private loans.
- Your monthly payments would remain the same, regardless of your employment situation.
Overall, if you see stability and rising wages in your near future, then refinancing could be a good play. But if instability and short-term wage reduction could be lying ahead, I would recommend holding off on a student loan refinance.
Note: This concern would only apply when refinancing federal student loans into private. Refinancing one private loan into another with a better interest rate is actually a good idea when career instability is expected. Why? Because federal income-based repayment plans aren’t an option to you anyway, so you might as well get your monthly payments down as low as you can.
5. Would refinancing help your parents get out of a co-signing commitment?
If you took out any private student loans while you were in school, there’s a good chance that your lender required your parents to cosign the loan. Cosigning arrangements create a great deal of risk for the cosigner, and in certain situations, even the borrower.
If you are now in a steady job and your credit has improved, there’s a good chance that you could get your parents out of their cosigning obligation by asking your current lender for a cosigner release.
But if your credit has improved to the point that your bank would allow a cosigner release, why not go ahead and refinance the loan and kill two birds with one stone?
Through a student loan refinance, you could accomplish your goal of removing your parents from your student loans while decreasing your interest rate at the same time.
This is probably my favorite scenario for a borrower to choose to refinance. It’s literally a triple win-win:
- Your current loan would already be private (since most federal loans don’t require credit checks or cosigners) so there’s no need to weigh the pros and cons of losing federal student loan benefits.
- You get to help your parents out by arranging their cosigner release.
- You get to help yourself out by lowering your interest rate and, thereby, your monthly payments!
6. Would refinancing shorten or lengthen your repayment timetable?
Private student loans lenders offer a variety of repayment timetables, typically ranging from 5-20 years. I love it when refinancing allows you to shorten the time it will take you to repay your loan.
Scenario #1
For instance, let’s say that you are in year 5 of a 20-year private student loan (15 years remaining) at a 7% interest rate. In this case, you may be able to qualify for a 10-year loan at around 4%.
In this scenario, your monthly payments would actually rise a little, but you would save a great deal of money in interest over the life of the loan and would pay off your loan 5 years earlier!
This is a great reason to refinance your loan.
Scenario #2
However, let’s change up the example and pretend that you refinance a 10-year loan into a new loan with a 15 or 20-year repayment timetable. It could be that you’re being offered a lower interest rate and your monthly payments will definitely go down, but you could actually end up paying more money over the life of the loan.
Scenario #3
Now, let’s change up the example one last time. Let’s say that when you were in college you took out a 15-year private student loan and 5 years later, you are considering a refinance.
In this case, if you refinance into a new 15-year loan, you would essentially be starting your repayment clock all over again. Your payments would go down, but you would be making 5 extra years of payments.
In a situation like that, I would instead recommend refinancing into a 10-year loan. That way you enjoy the benefits of the lower interest rate without stretching your payoff date further into the future.
The bottom line: unless you are in a situation of extreme financial hardship, I do not recommend lengthening your repayment timetable during a student loan refinance.
Conclusion:
Depending on your situation, refinancing your student loans could be a great decision or a big mistake.
But by first carefully answering the questions above, you can confidently move forward knowing that it will be a blessing for you rather than a curse.
For more student loan advice, check out our Complete Guide to Getting Out of Student Loan Debt.