Paying for college is challenging.
That’s why there are student loans in place to make the process easier. Federal loans are the most common student loan options that exist. Private loans are also there, if you prefer to go that route.
However, paying off student debt after you finish college is even more difficult than paying for college because you have to pay off the loan with interest.
One way to ease the load of paying off student debts is to refinance your loan through a private loan lender. This will help you get a lower interest rate, lower your monthly payment, and help you save thousands of dollars.
This might seem like a great option to help you manage your debt, but before you decide to refinance your loan, it’s important that you know the pros and cons of doing this.
And that’s what this piece is about—the benefits and disadvantages of student loan refinancing.
Let’s get into it.
What is student loan refinancing?
Student loan refinancing refers to when you apply to a private lender for a new loan to pay off your existing loans, usually to extend your payment timeline or lower your interest rate.
Student loan refinancing allows you to combine some (or all) of your loans into one new loan, at a lower interest rate that can help you pay less over time or with a long repayment timeline that will reduce your monthly payment. This works great if you have multiple student loans, although you can also refinance if you have only one loan.
If you are on a federal student loan, you have to refinance with a private lender. If you are on private student loans, you have to refinance with your current lender or pick a new one.
How can one refinance or consolidate student loans?
If you want to refinance your student loans, you have to choose which individual student loan you want to refinance. When you have made your choice, you should research private lender websites to see the rates and repayment terms that they offer.
Note that when you refinance your loans, you’ll lose federal protections like loan forgiveness and specialized repayment plans.
Most private lenders will ask that you enter basic information about yourself and your current loans in exchange for a quote. This is called prequalification, and unlike a formal application, prequalification does not affect your credit score negatively. So it’s the best way to compare the interest rates offered by different lenders.
Once a lender has approved you for a loan, the funds will be used to pay off your current student loans. After that, you’ll start making payments on your new refinanced loans. With a longer repayment time or lower interest rate, you’ll pay less money over time on your refinanced loan that you would with your previous loans.
If you earn a low income or have a poor credit score, you might not be approved for student loan refinancing. If you’re denied for refinancing, the private lender might give you a reason why. A cosigner who earns a good income or has a good credit score.
Pros of student loan refinancing
Below are the advantages of student loan refinancing:
Reduce your interest rate
Whether you opt for a variable or fixed loan, student loan refinancing can potentially reduce your interest rate. This could save you thousands of dollars, depending on the amount of money you need, and the new loan terms.
Say, you have $50,000 in private student loans with a 9% interest rate. That means you will pay $633 every month for the next 10 years. After you apply with a private lender for refinancing, you are approved to pay a 6% interest rate, which is lower. That would reduce the monthly payments on your $50,000 loan to $555.
This will save you $9,360 in interest, which you can use for something else.
Pay off your loans faster
Because you are paying less interest on your loan, you may be able to reduce your term length. Reducing your payment term length will help you pay off your student loans faster and pay less money overall.
Streamline your student loan management
Student loan refinancing is a form of loan consolidation. This means that refinancing student loans takes multiple loans for several lenders and merges them into one loan. This results in a single monthly payment and one due date, which helps you keep track of your debt, and reduces the chances of missing payments and making late payments.
Pro-tip: If you want to use a different process that allows you to keep a federal loan servicer, you can combine your federal loans into one payment with a Direct Consolidation Loan. This is only for federal loans, so you can’t include private loans.
Apply with a cosigner or release a cosigner from your loan
If you don’t have a great credit score or earn enough income to refinance your student loan by yourself, you can get a cosigner who earns more and gets a good credit score to help you get a better rate than the one you were originally offered.
However, if your parent or family member cosigned your student loan for college, they might want to be released from the contract. If your current loan lender doesn’t offer a cosign release, refinancing your loans will eliminate the cosigner because it’s a new loan.
Get a new loan servicer
If you are not happy with the service you get from your current loan servicer, you can simply research lenders who have a better reputation and refinance your loan with them. This will help you get into a new contract with a new loan servicer to whom you’d make all future payments.
Cons of student loan refinancing
Student loan refinancing can be a great option if you want to change the terms of your current loans, but there are some drawbacks you need to consider before you decide to refinance your student loans.
Not everyone will qualify for refinancing
There are certain eligibility requirements a student needs to meet before they can refinance their loans. And not every student can meet these requirements.
The requirements differ with each lender, but generally, lenders need to be sure that you have a steady job, a minimum amount to refinance, a good credit score of 650+ and a debt-to-income (DTI) ratio under 50%.
Pro-tip: To calculate your DTI ratio, just divide your total monthly payment by your monthly income. If you don’t qualify on your own, you’ll need a co-signer who does.
You will lose federal payment protections
When you refinance a federal loan, you will lose the protections that are attached to federal loans.
For instance, if you refinance your federal student loan into a private loan, you cannot qualify for Public Service Loan Forgiveness (PSLF) by working in the public sector. So if there’s a nation-wide cancellation of federal student loans, your loans will not be cancelled because private student loans are not eligible for student loan forgiveness.
You also won’t qualify for repayment options like Income-Driven Repayment Plans, which uses your income and the size of your family to calculate your monthly payments. With this plan, you can pay back 10-20% of your income for 20 to 25 years. You might even pay nothing, depending on how much you earn.
You might not qualify for deferment or forbearance
If you have a federal loan, there are options in place to defer student loan payments. These options allow you to temporarily postpone your loan payments if you become unemployed, if there’s economic hardship, or if you serve in the military.
If you refinance your federal loans, your deferment options become limited or even nonexistent because some private lenders won’t let you stop payments at all.
You’ll also lose the grace period that accompanies federal student loans.
Pro-tip: The grace period is the amount of time (usually six months) after you graduate, when you’re not expected to make any payments.
Variable rates can increase
When refinancing your loans, you have the option to choose a variable or fixed interest rate. If you choose a variable interest rate on your new loan, the rate can increase as time passes.
Variable rates are appealing because they start off lower than fixed rates but they fluctuate based on many factors and, in the long run, they can become more expensive than the fixed rates. That’s why you should only choose a variable rate loan if you’re sure that you will be able to pay off the loans quickly.
While student loan refinancing is an option that helps many students save money on their monthly payments, it is not suitable for every student.
Once done, it cannot be reversed. You can refinance again with private student loan lenders, but you can never go back to federal student loans. So if you are considering refinancing your student loans, do the following:
- Compare private lenders who offer student loan refinancing to make sure you get the best refinancing interest rates.
- Make sure your (or your cosigner’s) income, credit score and DTI ratio look great.
- Check the payment protections you would have with a private lender in case you experience a setback that can prevent you from making timely payments, e.g. losing your job.