Can You Refinance Student Loans To A Lower Interest Rate – Understanding the pros and cons of student loan financing is a very important topic. At , we talk daily with people who are bombarded with mailers about refinancing their Federal student loans after they graduate. They didn’t know any better and decided to refinance. Now they know they don’t have to do that.
This article discusses the pros and cons of refinancing. To be clear, we are talking about going from your federal loan to a private loan. If you have taken out a personal loan, continue to look for refinancing and probably do it. If you need additional help, be sure to read our Ultimate Guide to Student Loan Financing and check out our Free Student Loan Financing service.
Can You Refinance Student Loans To A Lower Interest Rate
The #1 reason to refinance student loans is to lower your interest rate and save money. How much you save depends on the term you choose, the type of loan (fixed vs variable rate student loan), and how you pay.
Read This Before You Refinance Federal Student Loans
One important thing to remember is the first myth of our 8 Myths about Student Loan Financing. You don’t have to refinance all of your loans. In fact, most people, especially graduates, will not want to refinance any loan depending on the level and / or terms of some existing loans.
Also, savings is only one of two things you should look at when financing your student loans. Budget flexibility is second (See below for details on this).
Finally, before refinancing, make sure you are 100% committed to paying off your loan effectively and quickly to maximize your savings.
This is a secondary purpose for refinancing and, in my opinion, should not be the main reason for doing a refinance in most cases.
Can You Refinance Your Student Loans Multiple Times?
When you refinance, your interest rate goes down. So all things being equal with your federal loan, your required monthly payment will go down. This translates into increased budget flexibility, as you can devote more funds to other financial needs (saving for a home, paying off credit cards, etc.)
The reason why I say this is secondary to savings is regardless of what your payment is required, you will most likely make prepayments to maximize your savings.
That’s why the budget flexibility of lower monthly payments is great, but saving the most money remains your #1 priority. Refinancing at a lower rate saves you money, making the payments will obviously save you more.
Prepayments on federal student loans are often blamed. There are often multiple loans with different terms and rates and student loan servicers sometimes fail to consider this when applying for a prepayment. For example, they can’t apply your down payment to the loan with the highest interest rate.
How To Refinance Your Sallie Mae Student Loan To A Lower Interest Rate
This costs lenders millions of dollars a year. We have found errors around 60% – 65% for members using the solution. Government data also shows that service providers make mistakes about 60% of the time.
We’ve seen many times where borrowers are so upset with their federal loan providers that they just refinance so they don’t have to deal with it anymore. Once you refinance, you only have one loan to manage and the private loan servicer usually applies the correct payment. People who refinance for this reason are looking for simplicity and accuracy.
Many borrowers are tempted to use short-term loans because they have lower interest rates compared to long-term loans. However, short-term loans mean higher monthly payments, all things being equal.
In fact, most of the savings on short-term loans are the result of higher monthly payments and not lower interest rates.
Ways To Pay Off Student Loans Faster (and Save Money)
For new graduates who are just starting “life”, our general recommendation is to prioritize budget flexibility at first and refinance into long-term loans until success. Then after you work for a while and understand your budget, you should look again to refinance short-term loans to maximize your savings.
If you help analyze the trade-off between short-term loans and long-term loans, ie. savings vs. budget flexibility, be sure to sign up and use our free student loan refinancing service.
In addition to losing budget flexibility, refinancing into a short-term loan can make it harder to qualify for a mortgage if buying a home is a priority. When home lenders consider your mortgage application, they will look at your debt-to-income ratio as an important variable. Your DTI ratio is calculated by comparing your monthly gross income to your monthly debt obligations.
So refinancing into a short-term loan saves you money when buying a home. This happens because you will increase your debt-to-income ratio. Check out this article on buying a home with student loan debt for more information.
How To Refinance Student Loans While Interest Rates Are At Record Lows
This is one of the biggest mistakes we see new grads make. When you refinance your federal student loans, you go from a federal loan to a private loan. This means you are no longer eligible for loan forgiveness.
With an income-driven payment plan, payments are based on a percentage of your income, which means lower payments. However, the amount forgiven is considered taxable income at the end of the plan.
So some people who want to go back on IDR think they have to refinance and secure lower rates. They believe that their tax liability will be reduced if the loan is forgiven.
However, one cannot use an income-driven repayment plan for a personal loan. So, if you refinance a personal loan, you will be “fighting” on a traditional payment plan and your monthly payments will go up.
When To Refinance Student Loans — Credible
This is even worse for those seeking forgiveness through Public Service Loan Forgiveness (PSLF). We’ve worked with a number of people at non-profits who refinanced without realizing it would disqualify them from PSLF. If you want to learn more about PSLF, check out our guide to Public Service Loan Forgiveness.
This is similar to the student loan refinancing above. However, it involves unexpected events like losing your job.
If you are on a federal loan, you have more flexibility. For example, if you lose your job and have no income, you can switch payment plans and enter an income-driven payment plan. Your required payments will be $0 per month and you will not be considered in default. You can also return to tolerance.
Once you refinance, you lose the ability to do the above. Each student loan financing company has its own parameters. For example, if you lose your job, you can postpone loan payments for 6 months. Every company is different, so be sure to check out our student loan financing company reviews to see what deferment features each company offers.
How To Refinance Student Loans
In short, if the majority of your income is unstable (such as commissions or bonuses), then refinancing is probably not for you.
Above we mentioned that some people refinance because they want to have one loan in one place and no longer want to deal with their federal loan service. That convenience comes at a price.
If you have federal debt, your required monthly payment decreases each time you pay off the loan. This gives you more budget flexibility (Note: This is true with every service provider except Great Lakes. You must drop it manually. For more information on payments with Great Lakes, check out this Great Lakes Guide).
When you refinance, you also consolidate your loan. This means you go from having multiple loans to one large loan. Therefore, your required monthly payment will remain the same until you pay off the loan in full or refinance it into another loan.
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If you are not familiar with the difference between refinancing and consolidation, I recommend you check out our article 4 things to know about student loan consolidation.
Another big mistake we see is borrowers using variable rate loans. Most do not need to use them especially now that we are in an increasingly variable rate environment.
This can be a costly mistake. People who don’t have the ability to repay the loan quickly are worst hit by this mistake. The appeal of variable rate loans is that they have lower *initial” rates than fixed rate loans. They are the “teaser” rates as many lenders call them.
If you’re thinking about refinancing with a variable rate loan, I highly recommend checking out our variable rate student loan refinancing guide.
When To Refinance Student Loans
Below is a table summarizing the pros and cons of student loan refinancing discussed in this article. If you want more articles about money, check out our blog page.
Article by Joseph Reinke, CFA. Joseph Reinke is a Chartered Financial Analyst (CFA) and founder. He has a finance degree with an investment concentration. He has been a private investor since he was 12 years old. Joseph has experience in mortgages, wealth management, investment banking, valuation, and stock and options trading.
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Student Loan Refinance 101
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