When Does It Make Sense to Refinance Your Student Loans?

When Does It Make Sense to Refinance Your Student Loans?

Recently, I’ve been seeing a lot of commercials for companies like SoFi who promise to refinance your student loans with lower interest rates, saving you thousands or even tens of thousands of dollars and knocking years off your repayment period.

It’s a pretty good offer. I mean, who doesn’t want to save tons of money and get rid of their student loans a few years sooner?

And to be honest, SoFi is a good company. I’ve even recommended them to clients. In the right situations, refinancing your student loans can be a really smart move.

But there’s a lot to consider before you dive in. Refinancing your student loans can have some unintended consequences, and some of them can cost you money and security.

There’s also a big difference between refinancing private student loans and refinancing federal student loans, and in this post we’ll look at the pros and cons of each so that you can make the best choice for your personal situation.

When does it make sense to refinance private student loans?

Deciding whether or not to refinance your private student loans is usually pretty simple. For the most part, if you can get a better interest rate you should do it.

There are two main reasons for this:

  1. A lower interest rate saves you money.
  2. Some of the newer lenders on the market – like SoFi, CommonBond, and DRB –  have started offering more favorable terms and conditions than many other private lenders. This means that refinancing could provide you with more options if you ever hit a rough financial patch.

Still, there are a few things to consider before automatically assuming that refinancing your private student loans is a good idea:

  • You’re likely to get the best deals when you have a good credit history AND when your credit score is significantly higher than it was when you originally borrowed.
  • Watch out for fees. Even with a lower interest rate, up front and ongoing fees could wipe out and cost savings.
  • Some of these loans have variable interest rates that could rise quickly if overall interest rates rise, which could significantly increase the cost of the loan.
  • Read the terms and conditions. Some loans offer more protections than others, such as the ability to pause payments during disability or unemployment. You’ll want to make sure that you’re not giving up anything important by refinancing.
  • Refinancing to a lower interest rate could still cost you more money over time if your new loan has a longer repayment period than your old loan. Of course, you could always choose to pay off your new low-interest loan in a shorter period of time to offset the difference, but that takes some purposeful planning.

But the bottom line is this: in most cases it will make sense to refinance your private student loans IF you can get a better interest rate. Simple as that.

Why you should be careful about refinancing federal student loans

Federal student loans are a much different story with a lot more to consider.

Federal student loans offer a number of helpful repayment options and borrower protections that you can’t get with private loans and would therefore lose by refinancing. And while it can still make sense to refinance in the right situations, which we’ll get into below, you’ll want to know exactly what you’d be giving up by doing so.

Here are three of the biggest benefits that you would lose by refinancing your federal student loans.

1. Income-driven repayment

Federal student loans are eligible for several income-driven repayment plans and private student loans are not.

These plans provide you with an extra level of financial security because of the fact that your monthly payments will decrease any time your income decreases. So if you decide to switch to a single income, or if you lose your job or change careers with a decrease in pay, you’ll be able to make those transitions with more room in your budget because your student loan payments will decrease as well.

And that’s not all! These income-driven repayment plans also lead to the…

2. Opportunity for forgiveness

Borrowers on either the Pay As You Earn or the Revised Pay As You Earn repayment plans will have their remaining balance forgiven after 20 years of payments.

Borrowers on the Income-Based Repayment will have their remaining balance forgiven after 25 years of payments.

And if you qualify for Public Service Loan Forgiveness, you can have your remaining balance forgiven in 10 years and the amount forgiven is TAX-FREE!

Now, waiting for forgiveness isn’t always the right move. But if your debt is significantly higher than your income and you expect it to stay that way for the foreseeable future, forgiveness can be pretty valuable. And you would be giving it up by refinancing.

3. Borrower protections

Federal student loans offer protections like deferment and forbearance that allow you to postpone payments when you hit a rough financial patch. If you have subsidized federal student loans, you can even defer your loans interest-free. And there are a number of other protections as well.

Private loans are not as flexible or forgiving, meaning that you may be stuck in a tough spot if your financial situation changes.

When it makes sense to refinance federal student loans

With all of those benefits, you should be very careful about giving up your federal student loans. Still, there are situations in which it can make sense to refinance.

Specifically, refinancing your federal student loans can be a good idea when you meet all of the following conditions:

  1. You have high-interest federal student loans.
  2. You have excellent credit and will therefore qualify for the lowest interest rates available when refinancing.
  3. You have a high, stable income that makes it unlikely that you’ll run into trouble paying off the loan. Post-residency doctors who won’t qualify for Public Service Loan Forgiveness are a good example of this.

If that’s the situation you’re in, you could potentially save a lot of money by switching to a lower interest rate, especially if you have a high loan balance. For example, refinancing a $60,000 loan from 6.8% to 3.5% would save you over $11,000, assuming you paid each loan off over a period of 10 years.

Just make sure to think long and hard about the stability of your financial situation and to make sure you understand all the terms and conditions of the new private loan you would be taking on. Saving money is great, but so is the flexibility offered by federal student loans.

There’s always a catch

The commercials make refinancing your student loans sound like a no-brainer, and in the right situations it can be a really smart move.

But there’s always a catch and this is no exception. It’s important to consider what you’d be giving up in addition to what you’d be getting, especially when looking to refinance your federal student loans.

So what about you? Are you thinking about refinancing your student loans? What questions do you have? Or if you’ve already refinanced, how did go about making the decision? Let me know in the comments below!

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2 Comments... Read them below or add one of your own
  • Travis @ Student Loan Planner December 13, 2016

    In my experience as a student loan consultant, it generally makes sense to refinance if your debt to income ratio is below 1.5. If you’d rather just get rid of your debt and be done with it, you can refinance up to a 2.0 debt to income ratio. Above that and you start to really benefit from federal interest rate subsidies. Also for private sector loan forgiveness, you’ll owe the big tax bomb payment. If your debt to income is high, then saving up for the taxes makes a lot of sense as the time value of money is in your favor when saving for a tax liability 20 to 25 years in the future

    • Matt Becker December 16, 2016

      I definitely agree with your point about saving ahead for the tax liability. That could be tough to handle otherwise.

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