Whether or not you should refinance your student loans is an important decision to make since it has the opportunity to save you thousands or even tens of thousands of dollars in interest throughout the life of your loans. Refinancing private loans is almost always a good idea if the numbers work out in your favor and you can save money from reduced interest. Refinancing federal student loans is a trickier situation, and we'll explain why.
Student loan refinancing
Student loan refinancing is essentially when a student loan borrower decides to consolidate their currently existing student loans, whether they be federal, private or even both, into a single, new, and usually very different student loan, where ideally, the interest rate is lower than the weighted average interest rate of all the previous student loans if they were bundled up together.
When you decide to refinance your student loans, you are now making a single monthly payment to only one student loan lender. And if interest rates have dropped since you took out your original student loans, and your DTI has improved and your credit profile and income-earning potential have also improved, the lender may offer a lower interest rate and a reduced monthly payment compared to the total number of previous monthly payments, which should allow you to save money (sometimes big time) and even pay off your student loan balance in full faster.
Student loan refinancing may not make sense, however, for federal student loans, since these loans usually qualify for federal repayment plans and student loan forgiveness and other protection benefits.
Before deciding to refinance your federal student loans, consider the following:
1. Understand how much money you can potentially save by refinancing your student loans
The new interest rate and monthly payment you'll be paying on your new student loan will be a function of your unique financial characteristics, so it's a good idea to try to quantify right off the bat how much you can potentially save when you refinance your student loans.
When you refinance your federal student loans, you will lose access to federal repayment plans, which could include forbearance options and federal deferral. However, many private refinance lenders allow you to defer your monthly payments or can even temporarily pause your monthly student loan payments from a year or so if you end up losing your employment position or start to face some sort of qualified economic hardship.
Our student loan refinancing calculator helps you calculate how much money you can save from refinancing your federal student loans and even your private student loans.
For example, if you have a $40,000 balance in student loans with an interest rate of 8% and a 12 year payment plan and you end up refinancing your student loans to a 4% interest rate and 10 year payment plan, you could save around $13,752 in interest over the course of your loan.
2. Determine if you would want to use income-driven repayment plans
Federal student loans offer multiple types of income-driven repayment plans for student loan borrowers. These types of repayment plans include Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE) and Income-Based Repayment (IBR), and other types of repayment plans. PAYE repayment plans, for example, have certain pros and cons attached to them:
Pros
This repayment plan helps low-income borrowers, so if you can qualify, you would have reduced monthly payments, as well as more time to pay off the loan and after 20 years your remaining balances would be forgiven. Additionally, there is an interest payment benefit. Your interest accumulates on your loans each month, but if you can't cover the interest with your monthly student loan payment, the federal government will actually help you by paying the difference for as many as three consecutive years on the the subsidized portion of any Direct Consolidation loans and Direct Subsidized Loans.
If you are interested in utilizing federal loan forgiveness plans or an income-driven repayment plan, it could be a good idea to refinance only your private student loans while keeping your federal student loans outstanding.
Cons
Since your interest accumulates on your loans each month, the overall loan will typically take more time to pay off since you will be paying more in interest. Additionally, you need to submit formal statements which show your income each year, so your monthly payments can be adjusted based off your earnings. Only Direct Loans are eligible for the PAYE repayment plan. Finally, if you do earn any loan forgiveness after a decade or two, you'll have to pay taxes on this student loan forgiveness.
3. Identify federal student loans with high interest rates
Typically, out of the majority of federal student loan types, loans from the Parent PLUS Loans camp or Grad PLUS Loans from graduate schools have pretty hefty interest rates. If you're a recent graduate student who finished medical school, dental school, law school or their MBA, and have seen your credit profile recently improve and you've landed your dream job within a couple months of graduating, refinancing your federal loans could also help reduce your interest rate, get a more favorable maturity term and save you money over the long run.
4. Understand your new student loan refinancing terms
Rate structure
Federal loans only offer fixed interest rates, so depending on which time in the interest rate cycle you take out your loans, each student loan borrower will be paying the same rate on the same loan type, regardless of their unique credit profile. For example, interest rates for Subsidized loans for undergraduates were 4.53% on or after July 1, 2019, and before July 1, 2020. One key advantage is that refinancing your student loan provides you with the option to accept a lower interest rate, especially if the market environment has shifted in your favor, along with your credit profile having improved.
Maturity flexibility
Private loans also usually offer more flexibility in terms of the maturity timelines for student loans. If you have a federal student loan with a maturity in 15 years, and your credit profile has improved, refinancing at a lower rate along with a lower maturity, such as 5-10 years, could save you additional interest over time. This allows you to even pay off the loan faster in the future after you refinance, if you get a promotion at your job or begin to better manage your monthly spending, since student loans don't have any repayment fees.
Next Steps
If your credit profile has improved, received a job with more steady or larger income and want to save money from interest or even pay off your student loans faster, student loan refinancing could be a great option. Even if you're not sure if you can qualify for refinancing, obtaining a quote for your rate is free and usually takes less than three minutes online. Additionally, refinance lenders usually do a "soft" credit pull, so there is no impact to your current credit score. This is especially useful if you want to shop around and want to apply to a couple of places to see who can give you the best rate.
