What are the pros and cons of refinancing student loans?
Refinancing can bring big benefits—but there are also some drawbacks to consider. Here are the key things to think about.
Pro: you can score a lower interest rate
When you refinance a student loan, a private lender pays off your old loan—and issues you a new one with a new interest rate. Ideally, that interest rate will be lower than before.
Each lender’s method of determining your new interest rate is different. The lender may take into account your:
- FICO score
- Income
- Debt situation
- Degree
- Career, and
- Earning potential.
No two lenders will give you the exact same offer.
However, you’re especially likely to score a lower interest rate in two situations:
- When your credit score is better now than when you took out your original loans, if you’re refinancing private loans.
- When private lenders offer interest rates lower than federal interest rates. Many federal student loans have higher interest rates than the lowest rates offered by private lenders. The current rate for undergrad Direct Student Loans as of July 1, 2018 is 5.05% (up 13% from last year). Older loans have lower interest rates.
But private lenders are offering interest rates as low as 2.47% on the low end. If you have good credit and can score a rate that low, you could save thousands by refinancing your federal loan with a private lender.
The government has its own semi-equivalent to refinancing with a private lender for federal loans: consolidation. But with this option, you don’t get a lower interest rate; your rate is determined by taking the weighted average of interest rates on all your loans, and rounding up by 1/8th of a percent.
So yes, you read that right. Sometimes when you consolidate with the federal government, you interest rate may actually go up.
Pro: You can reset your terms
Another good thing about refinancing is that you can reset the length of your loan.
Stretch it out longer and you can lower your monthly payment.
Make it shorter, and you can pay it off faster—and save a lot on interest.
Pro: You can replace multiple loans with a single loan
If you’re like many people, you have a number of federal and private loans with different lenders and servicers. This can present real logistical difficulties in keeping track of your loans, making on-time payments, and even knowing how much you owe.
Refinancing replaces multiple loans with a single loan—so it’s much easier to keep track of payments and payoff timeframes. You only need to pay one lender, and you can easily see the status of your loan at a glance.
Con: You lose federal protections for federal loans
The biggest potential drawback to refinancing federal loans is that you lose certain protections that are mandated by law.
These include deferment and forbearance options, death and disability forgiveness, and income-driven repayment.
Some private lenders, however, have made a real commitment to offering similar flexibilities and protections to their borrowers:
- CommonBond offers the CommonBridge program, which will let you postpone monthly payments for up to 12 consecutive months. You can put your loan in forbearance for 24 months total over the life of your loan. They’ll also help you land a new job.
- SoFi also helps you land a new job—with extensive career counseling, resume evaluation, and networking programs for its borrowers. They offer deferment for grad students, active-duty military members, and those undergoing rehab for a disability.
- Laurel Road offers up to 12 months of forbearance for economic hardship, plus forgiveness in the event of death or permanent disability.
- College Ave will let you pay only interest for the first two years of your loan.
If you’re worried about losing protections when refinancing a federal loan, you should talk with lenders about their hardship programs before making a decision.
Con: You lose access to student loan forgiveness for federal loans
Another drawback to refinancing is that, when you refinance federal loans, you lose access to programs such as Public Service Loan Forgiveness.
This program forgives your loan after about 10 years of qualifying payments—but it’s notoriously picky, even if you work for a qualifying employer. If you work in public service, it’s a good idea to do your homework sooner rather than later to make sure you’re on track to qualify. If not, it may be worth it to see if you can score a lower interest rate through refinancing.
If you enroll in income-driven repayment, you could also be eligible for forgiveness (of your federal loans)—after a period of 20-25 years, depending on the program. You lose access to that option as well if you refinance a federal loan.
Pro/con: Lender eligibility requirements will determine your interest rate
This is a pro if you have a good credit score. If you don’t, you may be better off sticking with the interest rate on your federal loan.
Lenders look at factors such as your FICO score, your earning potential, your degree, your income, and other factors when determining the interest rate to offer you on your refinanced loan. As with any other loan, such as a mortgage, you’re not guaranteed a good interest rate.
If you’re not sure how good of a candidate you are, it couldn’t hurt to fill out applications with a few of your top lenders. There’s no obligation to accept the offer, and most lenders will do a “soft pull” for your initial offer, which affect your credit score.
If the numbers aren't in your favor, spend some time improving your credit score and then reapply in a few months.
