Student loans make up trillions of consumer debt across the United States alone, financially challenging more than 40 million borrowers. With the average student loan debt coming in at more than $35,000 per individual, it is no surprise that many feel trapped and overwhelmed by their college debt load.
Keeping up with monthly payments, whether loans are federal or private, can be a daunting task. Because of this reality, some borrowers delay working toward their other financial goals, such as purchasing a home, starting a family, or saving for retirement. When student loan debt feels like it’s just too much to handle, refinancing may be a wise option. Here’s a quick breakdown of what student loan refinancing means, as well as the pros and cons of doing so.
What is Student Loan Refinancing?
The process of student loan refinancing involves taking out a new loan to pay off one or more original loans. Instead of paying for the original loans, a monthly payment goes to the new lender for the duration of your new loan term. Refinancing can streamline the repayment process, especially for those who have several different loans to manage each month.
Borrowers have the opportunity to refinance federal student loans or private student loans if it makes sense to do so. In either case, the refinance process means working with a new private student loan lender to get the loan funds. This differs from student loan consolidation, which is a strategy used for federal student loans only. There are several different factors to consider when going through the refinancing process which help you determine if it makes sense for you or not.
When it Makes Sense to Refinance Student Loans
Refinancing student loans can be a beneficial strategy in easing your student loan burden each month. With the right refinanced loan, you may be able to reduce your interest rate, which may ultimately lower the total cost of borrowing. More of your monthly payment goes toward the principal balance you owe instead of interest. This can result in a reduction in the amount of time it takes to repay student loan balances.
However, refinancing may also provide an opportunity to extend your repayment period. For example, moving from a student loan with a ten-year repayment term to one with a 20-year repayment term means you will pay far less each month. This can be helpful when you’re working with limited cash flow or you simply want to free up some cash to contribute to other financial goals. Extending the repayment term on a refinanced student loan is likely to increase the total cost of borrowing, since interest rates may be higher than shorter-term loans.
Refinancing also is a way to consolidate multiple loans into one monthly payment. From this perspective, a refinanced student loan makes it much easier to manage what’s due each month as well as track repayment progress over time.
Student loan refinancing makes sense for those borrowers who want to lower their interest rate, extend repayment to a longer term, or consolidate multiple loans into a single payment. While these benefits are helpful in getting a firmer grip on student loan repayment, there are times when it may not make sense to use this strategy.
When You Should Not Refinance Student Loans
Refinancing your student loans requires a healthy credit score and credit history. Private lenders want to feel confident that you are a responsible borrower with a long track record of on-time payments. If you do not have a solid credit score, refinancing may not provide the benefits you are seeking. For instance, borrowers with less than ideal credit may be offered higher interest rates than their current student loans charge, making the process less beneficial overall.
Private lenders may also require you to get a co-signer for the new loan. A co-signer is just as responsible for the loan repayment as you, which can make it challenging to find someone who is willing and able to take on this responsibility. If your credit is lacking, it may be worth waiting until it improves before applying for a student loan refinance.
Student loan refinancing may not be the right move if you have federal student loans. With federal loans, you have certain protections and options not available through private lenders. For example, borrowers have access to income-based repayment plans that can make loan payments more affordable, based on earned income. They also have options for forbearance should serious financial issues arise, like losing a job. Private lenders do not offer these strategies when you are refinancing a loan.
Finally, refinancing may not be the best choice if the interest rate you receive is higher than your current loans or is variable. Of course, a higher interest rate means paying more on the loan over time, even if you are able to extend your repayment term to lower monthly payments.
Having a variable interest rate, which may initially be lower than your current rate(s), is a gamble, given that the rate can rise in the future. If a variable rate increases, so do your monthly loan payments. Unless you are well-prepared to deal with this change in the future, student loan refinancing with a variable rate loan may not be a wise move.
Final Thoughts on Refinancing Student Loans
Refinancing your student loan debt may be helpful for several reasons, from lowering the interest rate paid to better managing your monthly payments. However, it is crucial to think through what you may be giving up. Federal loans offer benefits private lenders do not, including several repayment options should your income or financial life change.
You also have to qualify for a refinanced loan with a private lender, which may be a challenge if your credit isn’t where it needs to be. Consider each of these factors carefully before deciding on a refinanced student loan.
