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Refinancing student loans can be a tempting option for those struggling with high monthly payments and interest rates. After all, by combining multiple loans into a single loan with lower interest rates, you may see significant savings.
However, before making the decision to refinance your student loans, it’s important to understand that there may be a few potential downsides to doing so. If you’re weighing whether it makes sense to refinance, be sure to consider the advantages and drawbacks outlined below before signing on the dotted line.
Key takeaways
- Refinancing student loans can potentially save you money in the long run by securing a lower interest rate.
- Refinancing can also simplify the repayment process by consolidating multiple loans into one monthly payment.
- However, refinancing can also come with the loss of federal benefits and protections, so it's important to weigh the pros and cons before making a decision.
Top 5 considerations to make before refinancing student loans
Take a look at your entire financial portfolio, compare lenders and consider the pros and cons of refinancing student loans before making a final decision so you don’t end up in more debt down the road.
1. Pro: You can save money with a lower interest rate
If your goal is saving money in the long run, then make sure the new private loan has a lower interest rate than your original loans. A lower rate means that you’ll pay less in interest changes over the life of your loan and can reduce the likelihood of interest capitalization — when unpaid interest accrues and is added to your principal balance.
Most lenders offer prequalification, which lets you see your eligibility odds and predicted loan terms without impacting your credit score. When you apply for a refinance loan, the lender will do an in-depth review of your credit report, called a hard credit check, which lowers your credit score by a few points. To find the loan with the best rate, it’s important to shop around and compare lenders through prequalifying to minimize the impact to your credit score.
2. Pro: A longer repayment period can lower your monthly payment
Opting for a longer repayment duration for your student loans can lead to significant advantages such as reduced monthly payments. This could lighten your immediate financial load and make your monthly financial planning easier. However, it’s crucial to be aware that while your monthly outgo is less, the total amount you repay will increase due to the extra interest accumulated over the longer repayment term.
If you’re able to make a larger payment down the road and want to pay down your balance further, you can simply elect to make a larger payment. That said, you can’t elect to make a smaller payment unless you qualify through refinancing.
3. Pro: One payment is easier to manage
For those who have loans with multiple lenders, keeping track of every payment and the details of each loan can be difficult. Since refinancing involves consolidating multiple loans into one loan with a single payment, it makes it much easier to stay on top of your monthly payments.
For those with both federal and private student loans, refinancing can be a great simplification tool when communicating between lenders — especially because private and federal lenders operate differently and have different regulations. However, only refinance if you’re offered a more competitive rate than your federal loans and don’t plan on using the Education Department’s federal relief programs.
4. Con: You lose all federal benefits and protections
Federal student loans carry specific forgiveness and repayment benefits, including programs like Public Service Loan Forgiveness, closed school discharge, total and permanent disability discharge and borrower defense to repayment. When you refinance federal student loans, you’re essentially swapping them for private loans, which can result in the loss of certain federal benefits and programs.
The Education Department also offers hardship payment relief — temporary deferment and forbearance periods — to all federal borrowers, which can help reduce the risk of defaulting on your balance. Private lenders don’t offer uniform benefits and some offer more relief and repayment options than others.
Before making a decision, it’s crucial to balance these potential losses with the possible advantages of refinancing, which may include reduced interest rates or monthly repayments. Once you’ve converted federal loans to private loans through refinancing, there’s no way to change them back to federal student loans or reclaim the benefits of federal loans. If you think you qualify for federal debt or payment relief, you may want to put off refinancing while exploring the options available.
5. Con: It can be difficult to qualify for better terms
Qualifying for a lender without a co-signer can be hard if you have a lower income or a credit score under 650. Most lenders require proof of steady income, typically around $20,000 annually. While there are lenders that cater to borrowers with income, most still require a good credit score and relatively low debt-to-income ratio (between 30 and 36 percent).
Always consider the interest rates when looking for a loan that meets your needs. Loans that cater to borrowers with a less-than-stellar financial record often come with higher rates and less than optimal terms. Instead of borrowing a loan with non-competitive terms, take the time to conduct an audit of your budget. Look into your credit history and repayment trends to see what can be done to improve your creditworthiness.
Most of your credit score is based on debt repayment, so prioritize paying down high-interest debt every month on time and if possible, in full. Making at least the minimum payment every month can substantially help improve your credit over time.
If you can’t meet these standards, you might need someone with a good credit score and low DTI to co-sign for you. It’s crucial to remember that meeting these criteria doesn’t automatically ensure a lower interest rate. So, before you decide to refinance, it’s smart to use resources such as student loan refinancing calculators and prequalification methods to gauge potential savings without affecting your credit score.
The bottom line
Before refinancing your student loans, carefully analyze your financial situation and compare lenders to make an informed decision. While refinancing can potentially lower your interest rate and monthly payments, it may also result in the loss of federal benefits and require a good credit score to qualify.
Prioritize improving your credit and explore all options before refinancing. Use resources like student loan refinancing calculators and prequalification methods to make an educated decision. Don’t rush into refinancing and risk ending up in more debt down the road. Take the time to consider all factors and make a decision that is best for your financial future.
