Student loan refinancing can seem like a great idea, especially if your student loan interest rates are high or you’re having a difficult time affording your payments. And there is no shortage of options when it comes to refinancing your student loans through private companies.
There are certainly some good reasons you might want to refinance your student loans, but there are also some potential drawbacks to keep in mind. In this article, we’ll discuss specifically what student loan refinancing is, how it differs from loan consolidation, and the pros and cons of refinancing your student loans that are important for borrowers to know in order to make an informed decision.
Refinancing vs. student loan consolidation
Before we get into the pros and cons of student loan refinancing, it’s important to clarify what student loan refinancing and consolidation are. These two terms are often used interchangeably. Technically speaking, in any situation where you obtain a new loan with the purpose of replacing an existing loan or loans, you are consolidating debt.
However, in the case of student loans, consolidation typically refers to a federal student loan program that allows borrowers to combine their federal student loans into one. In a federal consolidation loan, the interest rate you get will not change, but will simply be a weighted average of the interest rates on your existing student loans. This is the main reason why the term student loan refinancing doesn’t work with federal consolidation loans.
The upside to a federal consolidation loan is that you can typically qualify for income-based repayment programs as well as many of the loan forgiveness programs that exist. It also offers the simplification that comes with having one student loan, as federal student loans are typically made on a semester-by-semester basis, and it’s not uncommon to graduate with a lot of individual loans.
On the other hand, student loan refinancing is usually used to describe lending products offered by private companies to consolidate student loan debt. A student loan refinancing interest rate is determined based on market conditions and the borrower’s credit score, and the length of the loan term varies depending on the lender’s offerings.
Pro: May be able to reduce your interest rate
Depending on the lender, your credit score, market conditions, and the interest rates you’re paying on student loans now, you might be able to reduce your interest rate by obtaining a student loan refinancing.
Here’s why this matters. Using a 10-year repayment period, if you have $30,000 in student loans at a 7% interest rate, your monthly payments will be about $348 per month. If you can refinance your student loans at a 5% interest rate, your monthly payment would drop to $318. That $30 monthly savings might not sound like a major difference, but over a 10-year loan term (120 monthly payments), it works out to $3,600 in interest savings.
Pro: May be able to pay off your debt faster or lower your monthly payment
Private student loan refinancing companies often have a greater variety of repayment options than you’re likely to find through the federal student loan program. For example, if the standard 10-year repayment plan offered by federal student loans results in a monthly payment that is a little too high, you may be able to find a 15-year student loan refinancing and spread your repayment out a bit.
Alternatively, you can find shorter repayment terms through private student loan refinancing companies, and these often come with lower interest rates than longer-term refinancing loans. For example, if you can handle a higher monthly payment, you may be able to find a private student loan refinancing with a 5-year or 7-year term.
Pro: You’ll have just one loan
To be fair, this isn’t just a student loan refinancing benefit. You can achieve this with a federal consolidation loan if you’re eligible, but then you won’t get the benefits described earlier.
Student loans are generally originated on a semester-by-semester basis. And if you qualify for direct subsidized loans, you may end up with both a subsidized and unsubsidized loan for every semester. Being able to combine them into one through student loan refinancing can greatly simplify your finances.
Con: No loan forgiveness with private loans
If you have federal student loans, there’s also the consideration of student loan forgiveness to keep in mind when deciding if student loan refinancing is right for you.
There is the Public Service Loan Forgiveness (PSLF) Program that forgives the remaining debt for certain public sector and nonprofit workers after 10 years of qualifying payments. There is the Teacher Loan Forgiveness Program that forgives debt for certain teachers after five years of qualifying work experience. And of course there’s the provision that forgives any remaining federal student loan debt for borrowers in income-driven repayment plans (IDR) after 20 or 25 years of repayment, which even includes years where no payment was required.
Private student loan refinancing makes your loans ineligible for any of these forgiveness opportunities. If you don’t anticipate qualifying for any type of student loan forgiveness, this isn’t a big deal. But if you might, it’s important to realize that by refinancing into a private student loan, you give up the possibility of student loan forgiveness.
Con: No income-driven repayment with private loans
Another big perk of federal student loans is the ability to enroll in income-driven repayment plans, which cap your student loan payments at a certain percentage of your disposable income. And if you don’t have any “disposable income” as defined by the Department of Education, your required payment could potentially be zero. As one example, the newly announced Saving on a Valuable Education, or SAVE Plan, limits your payments on federal student loans to as little as 5% of your discretionary income.
Some student loan refinancing lenders offer their own versions of flexible repayment plans, or the ability to pause payments in times of financial difficulty. However, income-based repayment can be a big perk of federal student loans for borrowers who qualify, so it’s important to realize that private student lenders don’t offer the same programs.
The bottom line
Like most personal finance decisions, there isn’t a one-size-fits-all answer when it comes to student loan refinancing. For many borrowers, especially those with high incomes and who aren’t eligible for loan forgiveness, refinancing can make great financial sense. But for others, the payment flexibility and loan forgiveness opportunities of federal student loans are extremely valuable and aren’t worth getting rid of.