Student loan refinancing can be a great way to lower your student loan loan payments. It just makes sense, right? You get a new loan, with a lower interest rate, and you pay less over time! It sounds win-win.
But, the truth is, that scenario is only the case with private student loans. If you have Federal student loan debt, you shouldn't typically look at refinancing your student loans. Remember, student loan refinancing is different than student loan consolidation. If you're wondering about student loan consolidation, go here.
Let's take a look at how student loan refinancing works, and why it only makes sense for Federal Loans in one specific scenario.
How Student Loan Refinancing Works
Student loan refinancing is similar to refinancing your home mortgage. Basically, you go to a lender, take out a new loan for $X, and use that loan to pay off all your other student loans. When you're done refinancing, all your other loans are paid, and you just have one new loan for $X.
Here's a breakdown of how it works.
As you can see, once you get your refinance loan, all of your other loans are gone.
Why It Makes Sense To Refinance Private Loans
It can make a lot of sense to refinance your private student loans. When you refinance your loans, you have the potential to lower your interest rate and lower your payments.
When you do refinance, it's important to look at both the interest rate, and the loan term. You can get refinancing loan terms from 2 years to 20 years, and the term length you decide on has a big impact on both your payment and the interest you'll pay.
Here's an example of how this can make sense financially from a client of my Ditch Your Student Loans program. He had the following private student loans:
By refinancing all his student loans into one new loan for $66,421, he was able to get the following:
This refinancing loan was for NO cosigner, and was based on him having excellent (780) credit. As you can see, even though the loan term is a little longer, because of the much lower interest rate, he's able to BOTH lower his monthly payment by 35% and pay over 50% less interest over the life of the loan.
If you're looking at refinancing, we recommend Credible - they are a student loan refinancing comparison tool that shops a bunch of different lenders for you to find the best rate.
Why You Shouldn't Refinance Federal Student Loans
When it comes to Federal loans, however, the story is different. The reason is, beyond the interest rate and payment, Federal student loans have a ton of perks and options to help borrowers.
First, if you're payment is too high, you could qualify for income based repayment. This will lower your student loan debt to less than 15% of your discretionary income (or 10% for PAYE and RePAYE plans). That means, regardless of what your loan amount or credit score is, you'll get a lower payment.
Second, these income-based repayment plans also include student loan forgiveness at the end of 20 or 25 years. That means, not only can you get a lower payment, but your loan could be forgiven after a period of time.
Finally, Federal student loans qualify for Public Service Loan Forgiveness, or PSLF. If you work for a non-profit or the government, you can get loan forgiveness after just 10 years. That's a huge perk.
If you were to refinance your Federal loans into a new private loan, remember: your new private loan replaces all of your Federal loans. As such, your new loan will have ZERO of these perks.
You might be thinking, well, I don't need an income based repayment option today. And that's fine, but can you say so with certainty tomorrow? Are you secure in your job and income level? Will you never work in public service in the next 10 years?
These are all important questions to ask.
The Only Scenario Refinancing Federal Student Loans Makes Sense
When you answer those questions, you'll quickly see that there is only one scenario where it makes sense to refinance your Federal student loans into private ones.
The ONLY scenario when it could potentially make sense to refinance a Federal student loan is if you meet all of the following requirements:
- You are currently paying under the Standard 10-Year repayment plan
- You are easily able to afford your monthly payments, and they do not exceed 10% of your take-home income
- You do not work in any qualifying public service or government job
- You don't plan to need income-based repayment within the next 10 years
- You are looking at paying your student loan off early or could possibly pay your loan off early
- You have excellent credit (over 760). We recommend Credit Karma as a free way to check your credit.
If you meet all of the above requirements, then refinancing your Federal student loan could potentially make sense as a way to save money over the life of the loan. The reason is that you'll likely never qualify for income based repayment since you can afford the standard repayment plan. Also, you'll never have an ability to apply for Public Service Loan Forgiveness.
To get the best interest rate and terms for a refinancing loan, you'll also need to have great income and a great credit score. If you have both of those, you'll likely be able to find a refinancing student loan with a lower interest rate and better terms than your Federal loans (but not always).
It never hurts to shop around if you fit into this scenario. Check out Credible and see if there's a better deal out there. It's free to compare loans, and you never know, you could save thousands of dollars over the life of the loan.
As a final reminder, if you have Federal loans, you typically do NOT want to refinance.
If you have private student loans, student loan refinancing can make a lot of sense.
The only exception is if you can easily afford your Federal student loans under the standard 10-year plan, and you meet the other criteria listed above.